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I would like to first say that I personally no longer purchase property via Lease-Option, however in the beginning that is all that we knew how to do so we had many successful lease option transactions. I know that many of you still prefer to purchase property this way so I would like to point out a few ways that you can protect your interest when buying via Lease-Option. Taking a few extra steps to protect your interest is very wise.
What can you do?
1) Memorandum of Agreement: At very minimum, file a Memorandum of Agreement with the county clerk. It is a very simple form that tells the world that you have some interest in the property. It places a “cloud” on the title. This memorandum will give you some protection if the seller files for bankruptcy, tries to sell the property out from under you or tries to get another loan on the property, which may make the debt more than your option. The Memorandum of Agreement does not require the seller’s signature, so there is NO reason why you can’t take this simple step.
The Memorandum of Agreement WILL NOT prevent liens and judgments from attaching to the property.
2) Have Seller Put Property into a Trust: This would prevent liens and judgments from attaching, but will not prevent the seller from selling the property out from under you (unless you’re the Trustee), and would not provide much protection in the case of bankruptcy. Combined with the Memorandum of Agreement gives you more protection, combined with a Performance Mortgage gives you very good protection.
Negatives: May be hard to explain and convince the seller to do.
3) Escrow Documents: You can escrow a Warranty Deed from the seller to you, and a quit claim deed from you back to the seller with an attorney or title company. When you pay off the debt, the attorney would deliver the deed from the seller to you. If you default, the attorney would deliver the quit claim deed from you to the seller. Advantage is that you don’t have to worry about finding the seller for closing, and it avoids the possibility that the seller may decide later NOT to sell to you. Should be combined with a Memorandum of Agreement or Performance Mortgage.
4) Performance Mortgage: A Performance Mortgage is a mortgage (or trust deed) on the property. The primary difference is that the words Lender (Grantor) and Borrower (Grantee) are replaced with Obligor and Obligee. A paragraph at the first part of the mortgage states that the mortgage is to secure performance of an agreement “your lease purchase” agreement. It would look something like this...
Obligor has executed a certain agreement dated JULY 14, 2000 ("Agreement") under which Obligor is under an obligation to perform certain acts, promises and/or covenants, which is valued at $10,000.00, which if not satisfied earlier, matures August 31, 2009.
This Security Instrument secures to Obligee the performance of Obligor's promises, covenants and agreements under this Security Instrument and the Agreement.
Once you file this mortgage with the county clerk you have VERY GOOD protection. You basically have a second mortgage on the house and you are afforded the same protection as if you had made a loan against the property.
Bankruptcy? – No problem, you are a secured creditor.
First Foreclosing? – As a lien holder you have a right to cure the default and start your own foreclosure. This should NOT be happening, because if you are not paying the mortgage direct, you better have a system set up to check that the mortgage payment is being made on time. Ask me how I know that?
Liens and Judgments attached? – If the seller does not have the funds to pay the liens and judgments off, you can foreclose them out.
No property insurance? – You have the right to obtain property insurance and make the seller reimburse you. If you are loss payee, as you should be, then you will get notice of any lapse in insurance.
Not paying association dues? - You can pay them and make the seller reimburse you.
Trying to sell it out from under you? - Not with your mortgage on there. What if he tries to sell “subject-to”? First, that would be very difficult with “your” tenant buyer living in the house, but if he did, you can exercise your rights of foreclosure. Of course your mortgage has a iron clad “due on sale” clause.
Trying to Refinance the First – Not without your permission.
Seller Obtains Another Mortgage? -- Not likely that he will be able to get a Third mortgage, especially when the new lender calls you to get the status of the second mortgage and you tell them that the property is under contract. So, if he does get another loan, he better have enough equity to pay it off at closing or you can foreclose on him.
There is no need to file a memorandum if you have a performance mortgage. You can however still take steps 2 & 3 above to give further protection.
You should consider a Performance Mortgage on EVERY lease-option.
* Instead of purchasing via Lease-Option we now purchase virtually all properties "Subject-To" or "Contract for Deed".