A lease-purchase option is a cross between a typical purchase contract and a lease. The agreement specifies the purchase price, amount of option funds (or nonrefundable payment the buyer makes toward the down payment), the length of the lease term, the amount of the monthly rent payment and the amount of the rent payment to be credited toward the purchase.

"Lease with an option to buy is a good vehicle for the right deal," said Chuck Nunnally of Alain Pinel in Los Gatos. "Let's say the buyer wants to get into the market but doesn't have a lot of cash for a down payment. So if you have a seller that doesn't need to close right away and is willing to take a chance and rent the home or, better yet, can't sell it for what they desire, then this would be a good scenario."

Nunnally, who has written his fair share of lease options, said the terms are pretty straightforward. The buyer and seller establish the price for a future sale and agree on the lease amount. The transaction involves three components—the lease, the option and the purchase agreement, which are all signed together.

"The buyer becomes the tenant. Usually the owner will ask for a higher than market rent with the provision that a portion of the rent will be applied to the down payment once the option to buy is activated. So, let's say the fair market rent is $3,000. The buyer and seller may agree on a $4,500 per month rent, with $1,500 or more being applied to the down payment once the option to buy is activated," Nunnally said.

Nunnally cautions buyers to remember that the purchase is an option. "Should the buyer/lessee not exercise the option during the option period, which might be one year, then the buyer in this example would forfeit not only the $3,000 per month rent but also the additional $1,500 payment. So, it can be risky for the buyers should they decide not to buy this home," Nunnally said.

The option agreement also needs some kind of consideration given to the seller at the time of the signing of the agreements, said Nunnally. "Usually it is a handsome amount of, let's say, $25,000. This money is given to the sellers at the time the buyers take possession. It is a nonrefundable option fee. This is what the seller takes as his security that the buyer is serious about performing at the end or during the option period."

Once the buyer exercises the option to buy, then the option fee is credited toward the down payment. However, if the buyer decides not to go through with the deal, the option fee would be forfeited to the sellers without recourse.

The purchase agreement is the standard contract form that is drafted and signed along with the other two agreements. This contract spells out the terms of the sale. Nunnally recommends getting all the inspections and diligence performed at this time.

"I give the buyer/lessee the 15 or 20 days' contingency to have the inspections and do whatever diligence is necessary as if they were performing now. This is due to the fact that if there are damages, termites, roof issues or any of the many things we contend with day to day in a sale, they are negotiated now," Nunnally said. "Once the buyer/lessee takes possession the place is now his, as-is, when and if the option is exercised. No surprises. The buyer/lessee may cause some of the so-called damages during tenancy. The lease agreement then spells out the recourse to buyers and sellers should damages occur during the lease period, especially should the lessee not exercise the option to buy."

According to Nunnally there are some caveats to the transaction, although he believes it is a good vehicle if both parties have the same needs and find this to be the best way to structure a deal.

"If the value goes up the seller loses out on the appreciation. If the value goes down the buyer may not want to pay a higher than fair market value and not exercise the option. The seller has to wait to get the equity from the sale to be performed down the road and he takes a chance on the condition of the home should he get it back. The buyer puts a lot of money up at risk if he does not exercise the right to buy," Nunnally said.

With such good financing options available today, Bill Challas with ConUnity Lending in Los Gatos believes a buyer should buy now, not later. "Ninety-eight percent of the contracts that have a lease with option to buy never go through. It sounds good to the buyer but it's a great deal for the owner. Most buyers either do not have enough income to qualify for a loan when they want to exercise their option or more than likely have bad credit. Today, there is 100 percent financing available, so a buyer should buy now, not three or five years later," Challas said.

On the other hand, George Monaco of Cashin Company in Los Altos believes lessee options do not favor the seller due to fluctuating market conditions.

"Of special concern is the option money. The option money must be given separate consideration and must not be refundable to the buyer. If the option money is in any way refundable to the buyer, then that consideration fails and the option is not legally enforceable. It may, however, be used as a portion of the purchase price," said Monaco.

Agents and landlord/sellers, unless otherwise exempt, must complete an agency disclosure, and a real estate purchase contract must also be provided with the lease with the purchase option form.

"Many other issues to note include the security deposit, mediation/arbitration of disputes, the exercising of the option, the termination of the lease, etc.," Monaco said. "The best advice is to have a competent real estate lawyer draw the lease option."