If I have the choice I always try and do a subject-to deal first and a lease option deal as a last resort. Why? Because with a subject-to I’m on the title, I own the property and I don’t have to deal with the seller anymore.
However, there are certain times when I’m unable to get a seller to do a sub-2, but I can get them to agree to do a lease option. The problem with the lease option is that I don’t own the property I only control it so there is more risk involved in the deal.
So how do I protect myself in a lease option deal and limit this risk? First off, I run a credit check on the seller. I want to make sure they’re not in any tough financial situation and that they’re not going to lose the home as soon as I’ve spent money finding a tenant/buyer.
For this same reason…
I also run a title search to make sure there aren’t any liens on the property or any information that the seller is hiding from me. Of course, I also use an authorization to release to verify the seller’s mortgage balance and their monthly payment. (The last thing you want to happen is that you think you’re taking over a $1,200 a month payment only to find out it’s really a $1,500 payment.)
Another very important thing I do in a lease option deal is to record an “option” at the courthouse so that I cloud the title. This is very easy to do and should cost you around $50. All you do is take your option agreement – which basically says that John Doe Realty has the option to buy 123 Main Street for $150,000 anytime in the next 5 years – to your local courthouse and have the clerk record it.
You want to make sure that you’re the one paying the mortgage every month on a lease option deal. No matter what, do not let a seller pay the mortgage. For all you know they could be pocketing the money you send them every month and not making their payment.
Even in instances where the payment you’re sending the seller is higher than the mortgage, you still pay the mortgage first. For instance, on a lease option deal I did in Baltimore, MD I agreed to pay the seller $800 a month. His mortgage was around $600 a month so he was owed $200 a month. I simply made the mortgage payment every month and then sent him a check for $200 a month. (I rented out the place for $1,000 a month and made $200 in cash flow myself.)
But what if the seller won’t allow you to pay the mortgage… or won’t allow you to check their credit… or won’t fill out the option paperwork so you can record it at the courthouse? Well… that should be a big clue for you that the person is not motivated enough and/or they’re dishonest and will probably be nightmare people to work with.
In other words, if that ever happens, simply walk away from the deal. Otherwise, make sure you follow the above guidelines with every lease option deal you execute.