These are both perfectly viable ways to purchase a house with no new loans and very little money down, but in today’s market, a sub-2 purchase is simply the better way to go. Lease options are essentially rental agreements, where the renter purchases the option to buy the house at some future date at an agreed-upon price. The seller is compensated for providing the option to buy, and he is bound to sell the home if the buyer chooses to exercise the option. A sub-2, on the other hand, means the buyer assumes the mortgage payments of a motivated seller, which can be done with little or even no principal investment (if you find the right seller!). Both strategies will result in your owning a house—one provides some flexibility at a cost; the other gets you a free mortgage.
Obviously, lease options should be reserved for buyers either who don’t currently have the money to buy a house, but plan to in the near future; or who are not yet sure whether or not they want to buy, as opposed to rent. You are going to end up spending the market rent while you stay there, and paying extra for the looming option to eventually buy the home—it can end up being very expensive if not negotiated carefully.
As an alternative, the investor who has little capital (or any investor, for that matter) should always consider sub-2’s, which allow you to buy a house for little or no money down, without taking a new loan, and without affecting your credit in the slightest way. As a buyer, you agree to take over the burden of paying the original owner’s mortgage (or other housing loan) payments, even though the financial structures remain in the original owner’s name and credit. If you are a savvy investor, you’ll find a motivated enough seller under enough pressure from the bank, who will not charge an additional rate beyond the mortgage. If he’s smart, he’ll want to stay on good terms with you, since his credit is in your hands. The bottom line is, you own a house, you’ve spent nothing but a monthly mortgage payment, and your credit is untouched.
Most investors shy away from sub-2’s that they know will negative cash flow. Smart move. However, there are ways to navigate and correct small imbalances in cash flow, so that you don’t have to waste the opportunity to own a perfectly good house with very little money. If you’re planning to rent the home, and you know that the market rental rate is $200 less than the monthly mortgage payment, rather than walking away you can simply charge the seller a monthly rate of $200 plus whatever monthly profit you want to earn from the property (say an additional $200). How? Simple. Do the research in advance so that you know going into negotiations that this is what you need for the property to cash flow, and simply make the seller’s monthly payment directly to you a condition of the sub-2 purchase. If you’re a reasonably good negotiator, you should be able to make a motivated seller realize that a $400 monthly check to you is better than a $2,000 monthly check to the bank. That way, even in the worst case event that the seller stops paying your monthly checks, just let the house go to foreclosure under his credit (include that in the contract as well).
Although lease options provide the buyer some flexibility as to whether he wants to buy or rent a home, it can result in an even more expensive transaction than simply renting or buying the home outright. Sub-2’s, on the other hand, give you ownership of the home (and all the benefits and tax deductions that go along with that), require no credit or loans, and take very little cash out of your pocket.
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