L/O and credit risk - Posted by johnny09

Posted by johnny09 on September 25, 2005 at 11:51:11:

Well, that’s interesting about “only one buyer”. Puts a little different perspective on it from Ben’s experience. L/O still doesn’t seem to me to be as “perfect” as the testimonials and guru’s make it out to be. Just one more tool in closing a deal I guess.

Can’t decide whether to go rehab + L/O or rehab + rental yet. Rehab + flip is a killer when tax time comes around!

Re: percentage of buyers + down payments. Thanks. That makes sense.

L/O and credit risk - Posted by johnny09

Posted by johnny09 on September 23, 2005 at 04:59:20:

It’s pretty easy for someone to get a home loan now with 0% down. Ameridream, etc. I’m trying to think through why they would want to go the Lease/Option route.

I guess the only reason would be that they have bad credit and if I do a L/O, the credit risk people are my market.

That is a little concerning because if aggressive mortgage companies don’t want them, they’re probably trouble.

What kind of credit score is high enough to be OK for L/O but too low for an aggressive mortgage company?

How likely is it that a high credit risk will have $5,000 for a non-refundable option payment?

Does anyone have a feel for what percent actually exercise the option?

Re: L/O and credit risk - Posted by William Bronchick

Posted by William Bronchick on September 25, 2005 at 17:03:39:

Johnny, I’m one of those “gurus” and if you read my course, you’ll see
that I do discuss a lot of what can go wrong and how to protect
yourself from it. My experience personally is right on with the people
who commented below - if the market is hot, you’ll get a lot more
people exercising. Also, screening and picking the right tenant/buyers
is the key. And, the more you get involved as the seller/landlord to
prod the buyers along, the more your exercise rate goes up. In hot
markets, seller/landlords tend to do NOTHING, hoping the tenant won’t
exercise. In soft markets like mine, we make our profit when they
exercise, so we call them every month and ask, “Have you called my
friend the mortgage broker yet?”

I don’t believe the aggressive lending has hurt the lease/option market,
in fact it has made it easier for tenant/buyers to qualify. Remember,
lack of credit or down payment are only 2 reasons why people do rent-
to-own. Case in point - I showed one of my houses today to a very
nice normal guy who just moved to town a week ago and doesn’t want
to do a straight rental. He’s living in a corporate subsidized executive
suite hotel until he finds something.

What IS causing the lack of interest for rent-to-owns is the supply and
demand factor. More landlords are offering rent-to-owns than they
used to. With interest rates down, more 1st time homebuyers are
finding homes, leaving demand for rentals down. When demand for
rentals are down, demand for rent-to-own also is down.

Nonetheless, lease/options are a GREAT way to sell, because you get
the highest price without an agent’s commission. Also, if the tenant is
in the property a year before he exercise, you can benefit from capital
gains tax rates or you can do a 1031 exchange with the proceeds and
pay no tax.

Just remember, every real estate strategy is like a tool in a toolbox.
You can’t fix everything with just a hammer.

Re: L/O and credit risk - Posted by Ben T

Posted by Ben T on September 24, 2005 at 19:28:03:


You bring up some important issues here.

It?s true that there are many, many routes for a borrower to go these days. Today, when I run a lease/option ad I get maybe 5% of the calls that I used to get years ago. Today I get people who are much higher credit risks, and typically have less cash to put up.

Do they create problems when they lose their non-refundable option payment? Some do. I had one do strip my place of the kitchen cabinets, and poke holes in the sheetrock, bust out all the storm windows. Mostly though, they don?t do that, but it?s something I always worry about. When the deal unravels sometimes it isn?t pretty.

One thing you didn?t bring up is that there is an issue concerning whether they actually make the repairs they are contractually obligated to make. I?ve gotten houses back that were disaster areas.

Bottom line is that there are plenty of issues in a lease/option. And you rightfully should consider each of them. What I have found is that an upfront consideration that I get I usually spend, one way or another, in repairs, legal expenses, vacancy while re-leasing, etc. So don?t spend that money too quick.

What I have decided is that a leopard never changes his spots. Many of the people that the lease/option appeals to are people who literally cannot be financed any other way. They enter into the deal with good intentions. But sooner or later, they revert to the very behavior that led them to have to do a lease/option to begin with. I?ve decided that lease/options are basically glorified rentals with considerably more cash protection than the typical rental deposit.

None of this necessarily negates the lease/option as a tool. I?ve made a lot of money doing them. But enter into them with your eyes wide open.


Re: L/O and credit risk - Posted by MatthewC

Posted by MatthewC on September 23, 2005 at 09:57:30:

If you are in a highly appreciating market, there is a greater likelihood of exercising the option due to the fact the value of the appreciating property helps overcome credit issues in the loan approval process.

In my area where appreciation is low, options being exercised is low. But that is ok, we expect it.

The market for L/O is much softer now due to all the low loan programs to purchase. L/O is fundamentally a tenant-based arrangement. Rentals in many places are softer the last few years.

However, that will change. L/O will become popular again.

Having said all that, there are still people who love our program and they are well-suited to it. Most of our portfolio consists of good-performing people with the occasional bump on the road.

Regarding the $5K. It all depends on the house and the area you are in. $5K might be a small fortune in some markets. In other areas, it is simply spare change.


Re: L/O and credit risk - Posted by DP (ON)

Posted by DP (ON) on September 23, 2005 at 07:53:20:

I find that credit score has no bearing on whether or not a T/B will pay their monthly obligation to me. Very often these people will pay their rent/mortgage instead of their credit cards or car payments, thus their credit looks bad but they actually are a very good risk for house payments. In line with this, I don’t bother to check credit anymore when considering a T/B candidate.

Depends on prices in your area. I don’t have any trouble finding people with $5k to put down, but that represents less than 2.5% of the average home value.

Nationally (both the US and Canada) it’s about 20-25%. If your market is appreciating this usually works out in your favor, because you can renegotiate or resell the house for more.

Re: L/O and credit risk - Posted by johnny09

Posted by johnny09 on September 26, 2005 at 07:52:11:

Mr. Bronchick,
Thank you for your response. You are one of my favorite REI authors, due to your well thought out and balanced approach, contrary to many of the “wild-eyed”, be-an-instant-millionare types. I wasn’t thinking of you when I spoke about “gurus”.

I’ve done rehab to one degree or another for many years, although not in an investment context. I love tools. When I was on a “rush” about nail guns, I’d try to use my gun(s) for everything I could. It killed me to admit I needed to use screws for something. Just like your analogy of the hammer. You need a lot of tools and you need to know when to use each one. L/O might not be the solution for every house.

With the market being so soft due to financing options available now, I would think as investors we would likely pass on more deals than normal due to the critical need to get a deal with enough room to sell, rent or L/O at a little under market.

Re: L/O and credit risk - Posted by johnny09

Posted by johnny09 on September 25, 2005 at 11:24:48:

Ben, you kind of confirmed what I’d been thinking about L/O deals. I read so much by the guru’s and in the testimonial postings on how L/O is the best thing ever but don’t often hear anything about the balancing downside of L/O. It may have been the best thing ever some years ago, but times have changed and financing opportunities have changed. Not saying there still isn’t money to be made with it, it just seems more difficult now.

Your leopard spots analogy is excellent.

On the face of it, you would think that if you want do L/O’s you would want to stay in the lower middle class price area (or perhaps even a little lower). However, in order to minimize trouble might it be better to move to middle class prices or a little above and try to attract a better clientel? Of course then, your pool of buyers is even smaller because those buyers will not likely have credit issues. Thoughts anyone?

Re: L/O and credit risk - Posted by Gerald(NC)

Posted by Gerald(NC) on September 23, 2005 at 10:17:31:

I had a dude gonna put down 20%, and I would have gotten $15k in my pocket at signing. He had a 350 score due to tax issues he had taken care of, and some credit bills his ex ran up that he didn’t/wasn’t gonna pay. With the $15k, I was gonna put $10k back just in case he walked away, I’d have the reserves to pay the mortgage for almost a full year.

So just be smart, figure your hlding costs if they walk away, and make sure you are prepared.

Re: L/O and credit risk - Posted by johnny09

Posted by johnny09 on September 24, 2005 at 14:26:48:

Do any of you have any trouble when they walk, regarding the non-refundable option payment? The possibility is certainly there of them getting mad and doing $5,000 (or whatever amount) of damage to the house just for revenge…then vanishing.

And DP, are you saying that 20% non-refundable down is the average amount?

Re: L/O and credit risk - Posted by DP (ON)

Posted by DP (ON) on September 24, 2005 at 16:31:47:

I’ve only had one buyer cause damage to a house and it wasn’t malicious, more like DIY improvements gone wrong.

No, the 20% I was referring to is the percentage of buyers who complete the purchase.

Average down payments for me are around 5%.