As the Kentucky real estate market continues to evolve over the coming months, a question we receive frequently concerns alternate methods of property “acquisition”, and the two most common methods are through the use of lease options and contracts for deed. However, we have discovered that many individuals confuse the two concepts, and it is important that you are aware of the distinctions between them.
Lease Option: This is a situation that really involves two separate concepts – a lease and an option to purchase. The lease element creates a landlord/tenant relationship between the seller and buyer, while the option is an agreement in which the seller gives the buyer the right to purchase the property, usually at a fixed price set at the execution of the agreement. This option is different from a standard purchase contract, in that an option only binds the seller to the sale … the buyer is not bound to buy the property in any way.
Contract for Deed: This is similar to the manner in which many people finance the purchase of a car – a buyer makes scheduled, pre-determined payments which gives the buyer equitable title to the property, while the seller still maintains legal title to the property as security for payment. Then, when the buyer pays the full amount due under the contract, the seller gives legal title to the buyer. The “titles” owned by the parties here are important to remember, as equitable title gives the buyer the right to live in the property, improve it, rent it and enjoy all benefits of ownership, but since they do not have legal title, they cannot use it as collateral for a loan.
So what are the advantages (and disadvantages) of each arrangement? The payments of interest under a contract for deed are usually deductible as “mortgage interest,” even though the buyer does not have legal title to the property, so this clearly can be a benefit to the buyer. A contract for deed also allows a seller to get more of a down payment (and a higher monthly payment) from the buyer, as opposed to the down payment you might receive under a lease option (usually in the form of a security deposit) and the rental payments to which a seller is limited to collect. Also, with a lease option, a seller is essentially a landlord until the buyer exercises the option, so the seller has all of the responsibilities and duties of a landlord, such as addressing repair and maintenance details. However, if the buyer fails to make payments under either arrangement, a buyer is much harder to get out under a contract for deed, since the seller will have to foreclose on the property to resolve the situation, while a seller can simply evict a buyer under a lease option. For a more thorough explanation of these concepts, feel free to give us a call.