In the early hurly burly days of lease option rent to own and refinancing – sometime back in the 2000s – managing clients in need, the lease option contracts, and generally all the many moving parts seemed to many of us like the rootin’ tootin’ wild west. There were so many overnight companies springing up to help homeowners with their refinancing, as well as putting young couples into homes they could ill afford.
Not surprisingly, many of the transactions went horribly wrong. Lease option operators gained the reputation of fly-by-night shysters who would not only disappear with clients’ security deposits, but also with investors money too.
Thankfully, there has been some improvement in operational processes for the serious investors and lease option refinance and rent to own companies out there who honestly want to provide a much needed service to a segment of the real estate market that needs it. But there’s still a lot more work to do, which is why I keep harping on doing lease options the right way.
Doing Lease Option Refinancing and Rent to Own Properly
Is there a proper way to do these lease option transactions? You bet there is! Ten years ago, the focus of these processes was on putting money in the investors pocket right up front. Typically, a lease option refinance client would sell their home to an investor, and their security deposit coming out of their equity would go straight into the investors pocket. I can’t tell you how many problems this one act has caused investors and homeowner-buyers. The thinking at the time was that mortgage lenders only needed to see that the original homeowner had paid a deposit, and the investor would “credit” this amount to them. Problem is, virtually all lenders need to see actual cash in the bank, not a credit. So at this point, the investor cannot show the money (he’s spent it or reinvested it elsewhere), and the homeowner-buyer certainly can’t show it. So often at the end of the refinance term, the homeowner-buyer was not able to get a new mortgage, and according to the lease option contract, they end up losing their home and their security deposit.
Rent to own situations were not much better. In these cases, tenant-buyers would pay a monthly surcharge that would be credited back to them at the end of the term. This would add up to become their downpayment. Again, the problem was that the investor pocketed this extra cash, spent it elsewhere, and when it came time to get a new mortgage, the lenders refused.
Hence, the reputation of lease option investors and agents was sealed in a terrible light.
The easiest way to fix these types of problems and to rebuild a reputation as an honest broker is to keep all security deposits and extra monthly fees that clients pay you in a trust account. That is, if you’re doing a lease option refinance, when you accept the security deposit from the client, you put it in trust. Then, the only time you would access it is if the homeowner-buyer misses his rent or something similar. In other words, it is not “free money”. It needs to be managed effectively, openly, and honestly.