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morganREI

Option money

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Hello, I'm new here.

 

I have a few questions.....

 

1. When a t/b exercises their right, do you return their option money in a form of a check at closing or discount on purchase price?

 

2. Does option money need to be kept in an escrow account?

 

3. How can you keep option money as a fee when assigning the contract back to the seller... doesnt this leave the seller holding the bag. When the t/b opts to buy, the seller has to come up with the opt-money right??

 

thx

morgan

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Hello, Morgan, and welcome to The Naked Investor!

1. When a t/b exercises their right, do you return their option money in a form of a check at closing or discount on purchase price?

Option money is never returned. It will either be a credit towards the agreed to purchase price, or used as part of the buyer's down payment, depending upon their chosen lender.

2. Does option money need to be kept in an escrow account?
No. It's nonrefundable, and it's your's.
3. How can you keep option money as a fee when assigning the contract back to the seller... doesnt this leave the seller holding the bag. When the t/b opts to buy, the seller has to come up with the opt-money right??
Again, when the t/b exercises their option to purchase, their option money is not refunded. So the seller isn't left holding the bag, as you say. That option money will either be a credit towards the purchase price or used as part of the buyer's down payment. The seller needn't come out of pocket.

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1. When a t/b exercises their right, do you return their option money in a form of a check at closing or discount on purchase price?
This is normally deducted from the purchase price and is set up in your contract stating such (from the beginning) No actual check needs to leave your hands

 

 

2. Does option money need to be kept in an escrow account?
No. It's not a renters security deposit where you would have to worry about commingling funds. This does not need to stay in escrow

 

 

3. How can you keep option money as a fee when assigning the contract back to the seller... doesnt this leave the seller holding the bag. When the t/b opts to buy, the seller has to come up with the opt-money right??
Your"fee" is factored into the house purchase price in the beginning (read, added in. Seller gets 250 out of the deal, you give an option of 255) You leave the picture, the option price is still the same to the buyer, seller still gets the same amount. Nobody is left holding the bag because the money was "added in" at the very start. Nobody ever has to come up with option money (in check form) It is just deducted from the purchase price

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Thank you for answering my questions.

 

Michael C,

 

Bad choice of words, I'll try not to use the word "return" when it comes to option money. Dont give up on me yet. I might just turn out to be a better student than Christine. Hee, hee, hee.

 

morgan

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Thank you for answering my questions.. . . Dont give up on me yet. I might just turn out to be a better student than Christine. Hee, hee, hee.

 

morgan

Maybe. . .but how do you look in a dress and heels? :P

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I know this was an old post, but I'm just trying to wrap my head around all the contracts and how the option consideration works out. So in the above example:

 

$255,000 sales price is agreed to with seller and written as such in Option to Purchase agreement on #1c (with minimal $5 option consideration given to seller under #3) - with seller understanding from the beginning that they are in essence only getting $250,000 minus rent credits.

 

OR

 

$250,000 sales price is agreed to with seller and written as such in Option to Purchase agreement on #1c (with minimal $5 option consideration given to seller under #3) - with T/B being told that their purchase price is $255,000 (even though it's now shows at that price in the option to purchase agreement).

 

Thanks,

Paul

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Paul, I'm assuming you are talking about doing a CA, first of all. So my answer will be based on this.

On the Option to Purchase Agreement, the purchase price listed in 1C is just what it says: the full purchase price. That is the price you would be advertising online and in the newspapers, for example. The price you tell prospective tenant/buyers when they call.

Quick example:

1) Purchase Price: $300K, (this is what paragraph 1C would reflect)

2) Monthly Rent: $1,500

3) Rent Credits: 50%, $750/mo, $9,000/year

 

Your marketing results in a t/b with $6K option money. All checks out and the deal is struck. The bottom line is the net sales price to the homeowner is $285K. That's $300K less $6K option money, (that's your's), and less $9K in rent credits. So the homeowner is getting what you told them they would and they're pleased. You made $6K for being so smart. The t/b is getting the house they want today without having to put down 20% and worry about quailfying now.

Does this help?

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Hey Michael,

Thanks for the quick response as usual. Yes, I'm thinking of a CA specifically. I think I get the idea now. So in your example, I would agree to $285,000 as the sales price with the seller, but market to T/B at $300,000 (which is price i would place in option to purchase agreement.

 

Is 50% rent credit a typical percentage to give to T/B in these agreements? Do you have trouble with getting this type of credit allowed by the seller? One seller I spoke with before was against any rent credit, but I think he was being unreasonable.

 

Thanks,

Paul

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The key is to be sure that the $300K price is acceptable to the market. If you promise homeowners everything they want, including an unrealistic net price, yeah, you'll get the deal but you'll never move it on the other end. Especially these days. And I mention that because this is a common mistake among n00bs. So be careful.

As for rent credits, they are a critical piece of the puzzle. I use 50% as my starting point and depending upon the deal, I will go to 75% and even 100%. They are key to getting the phone to ring. As for homeowners who oppose them, it's only because they don't understand them. Your job is to make the homeowner focus on the net price. If they're happy with that and it's realistic, that should be all that matters to them. If you are explaining the deal correctly, they will understand the rent credits will help move their property quickly and that they are added to the net price, not deducted from it. If that stil doesn't open their eyes, then yeah, they are unreasonable.

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3) Rent Credits: 50%, $750/mo, $9,000/year

 

First time poster, I had a question regarding this rent credit. Isn't it just a principle reduction? Won't the bank have an issue when they go to refinance this? I know that it sounds a lot like some of the "investors" were doing out here in Michigan and the banks wouldn't consider it towards a downpayment.

 

"It's important to note that most sellers will usually only allow a credit to the buyer if the monthly lease payment exceeds the property's fair market rental amount. Going back to our previous example of $1,000 per month payment, monthly credit would only be given if the lease payment exceeded the fair market rent. So, if $1,000 is actually the fair market rent (this is usually determined by an appraiser or other market expert) the buyer would have to pay $1,100 in order to receive a $100 per month credit toward the property's sale price or closing costs"

Lease Purchase

 

Thanks,

Jason

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HI, Jason, and welcome to The Naked Investor.

You are correct in that rent credits rarely will be considered as part of a t/b's down payment. Didn't used to be that way, but situations change and lenders aren't as flexible and happy as they were years back. So to be safe, your paperwork should reference that rent credits are a credit towards the purchase price. Therefore, if a t/b earns $10K in rent credits and the purchase price is $300K, the t/b now owes $290K and would need to go through the normal process of qualifying for the mortgage.

It's important to note that most sellers will usually only allow a credit to the buyer if the monthly lease payment exceeds the property's fair market rental amount. Going back to our previous example of $1,000 per month payment, monthly credit would only be given if the lease payment exceeded the fair market rent. So, if $1,000 is actually the fair market rent (this is usually determined by an appraiser or other market expert) the buyer would have to pay $1,100 in order to receive a $100 per month credit toward the property's sale price or closing costs

On this point I disagree. A seller can offer any amount of rent credit they like. These days I use 50% as my starting point, and have gone as far as 100% if the numbers and the market require this. If the purchase price is $300K and I'm giving the t/b $15K in rent credits, the purchase price is now $285K. The purchase and sale agreement would simply reflect this adjusted. What's a lender going to squawk about?

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On this point I disagree. A seller can offer any amount of rent credit they like. These days I use 50% as my starting point, and have gone as far as 100% if the numbers and the market require this. If the purchase price is $300K and I'm giving the t/b $15K in rent credits, the purchase price is now $285K. The purchase and sale agreement would simply reflect this adjusted. What's a lender going to squawk about?

 

This is exactly my question. Isn't the idea of the rent credit so that the t/b would have a portion of the down payment? Maybe I misunderstood the reason for the rent credits? Just getting the purchase price down doesn't mean that the buyer will be able to qualify for a mortgage and that would it seem would be our end goal. So if the property appraises for $300K and we sell it for $285K then the bank will just assume that $285K is 100% of the value. What is the point of the of the rent credit if not to make it easier to finance?

 

Thank you for your quick response.

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Jason, the point of the rent credits is two fold. First, they are an effective marketing technique. Prominently advertise a Rent To Own with a 50% or more rent credit, and your phone will be buzzing. Second, they do serve the purpose of reducing the purchase price of the house, so that the t/b isn't flushing their money down the drain as in a traditional rental. That lower price will make financing easier.

That said, you are correct in assuming there is no guarantee the t/b will qualify. But who said there was? At some point they will be responsible for taking care of the financing if they intend to follow through and buy.

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I hear potential tenant/buyers say all the time they hate throwing away their money on rent.

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That said, you are correct in assuming there is no guarantee the t/b will qualify. But who said there was? At some point they will be responsible for taking care of the financing if they intend to follow through and buy.

 

Two more question then, the goal of the investor here is to get paid and not just provide a service. If the t/b doesn't buy the property then how are we going to make a significant income. Cash flow is not going to be enough with the initial deposit to make these deals worth it.

Also if we are giving rent credits and they don't follow through on the purchase of the property then they have a perceived amount of equity in the property. I have heard cases of Judges awarding that equity back to the buyer even though they defaulted on the property. How do you protect yourself from that?

 

 

Sincerely,

 

Jason

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