An option contract is an agreement that lets you pay for the right to buy certain property in the future. Buying an option does not require you to buy the property. But if you later choose to, you can follow the steps in your option contract to require the owner to sell you the property. Option contracts between a landlord and a tenant are sometimes called lease option agreements.
This article explains some risks and facts a tenant should think about before deciding to pay for an option.
How an option agreement works
An option agreement often serves two main purposes: (1) to keep the owner from selling the property to someone else during the term of the option, and (2) to lock in a purchase price.
You don’t have to exercise the option, but you will ordinarily lose what you paid to buy the option.
|If the property value goes below the price that is locked in, the buyer may choose not to exercise the option. If the property value is more than the price locked in, and the buyer can afford to do so, the buyer is likely to exercise the option.|
Facts to consider when thinking about an option agreement
To decide whether to buy an option, it is important to know:
- the current and projected future value of the property;
- how you will get the money to buy the property; and
- how much interest you will pay if you need to borrow money to buy the property.
Buying an option is risky, and can be expensive. Options are most often used by commercial buyers in large real estate deals. A landlord renting residential property may charge you several thousand dollars for the option to buy the property in the future. The option contract may be part of the lease, or may be in a separate document.
If you are not able to borrow enough money to buy the property before the option expires, you generally lose the money you paid for the option. Lenders will deny a loan if they do not think you will be able to make mortgage payments over time. They might also deny a loan if they appraise the property and believe it is worth less than the purchase price set by the option.
Risks of buying property from the owner without a lender
The owner may agree, in the option contract or later, to let you pay the purchase price directly to the owner over time. That means you don’t have to get a separate loan. This can be helpful, but it can be risky too. Without a separate lender, there may be no one to make an informed, realistic assessment of the value of the property, or of your ability to make the ongoing payments. You may end up paying more than the property is worth, paying higher than normal interest, or paying more of your income than you can sustain.
Can I lose the option to buy?
Lease option agreements often provide that the slightest failure to follow the lease makes the option void.
Am I buying or renting?
Sometimes, after making an option agreement, tenants aren’t sure whether they are buying or renting the property, and landlords may demand that tenants make all repairs and pay taxes. A tenant who has not exercised an option is a tenant, not a buyer. Generally, unless the tenant exercises the option, the landlord must make repairs and pay taxes.
Special language required for lease option agreements
"Section 8-202 of the Maryland Code, Real Property," is the only law that specifically addresses option agreements between residential landlords and tenants. It defines a lease option agreement as any clause in a lease agreement or separate document that gives the tenant some power, either qualified or unqualified, to purchase the landlord’s interest in the property.
The law provides that a lease option agreement must state in capital letters “THIS IS NOT A CONTRACT TO BUY,” and must contain a clear statement of the purpose of the option and how it relates to a tenant who may wish to buy the property in the future.
If the option agreement does not contain the required statement that “THIS IS NOT A CONTRACT TO BUY” and a clear statement of the purpose and effect of the option, the party that did not draft the agreement (often, the tenant) may declare the lease, or the option, or both, to be void.
Read the Law: Maryland Code, Real Property, Section 8-202