Article of the Month for July 2005

The Lease Option Bugaboo

by Ward Hanigan

It's an almost 100% certainty that if a seller gets their attorney involved in a sale where you're putting very little down and proposing the use of a title holding trust to sidestep a due-on-sale contingency, the attorney will propose the use of a short-term lease with an option to buy instead.

Why? Because attorneys commonly think that lenders don't consider a short-term lease a significant enough shift in the control of property to justify calling their loans due. However, the longer a lease runs the more such an arrangement takes on the aspect of a sale.

The test of short-term versus long-term is actually set out in the federal Garn-St. Germain Depository Institutions Act of 1982. A lease term longer than three years is thought to be so prolonged as to be tantamount to an outright sale, especially if the lease is coupled with an option to purchase. In such a case a lender would be within their rights to call in their loan.

Another reason attorneys favor the lease option is that they feel it would be easier and faster to evict a defaulting lessee rather than going through both a foreclosure and subsequent eviction.

But a lease option is a poor substitute for the transfer of ownership via a title holding trust because:

However, if in spite of all the above negatives, you elect to participate in a lease option as a lessee then I'd suggest trying to use as short an agreement as possible. It seems that the longer such an agreement is the more controlling and intrusive it ends up being for the lessee.

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