Getting the Paperwork Ready

Now that you’ve found the motivated seller perfect for a lease option, determined the technique and profitability, and the deal is negotiated, you will next need to get the paperwork ready to be signed by the seller.

For a lease option deal there are different contracts and forms that need to be signed. There are also steps that need to be taken to complete and organize a lease option deal. I use a checklist so that I don’t forget any step during the process and can be confident that all items are completed.  This is most important when you are new or when you have many properties going at one time.  When you are experienced you will know what needs to be done and likely not forget much, however, when you have many properties (like I have had at one time), it becomes more difficult to keep everything straight in your head.  Things will potentially slip through the cracks.  A checklist is very important to keep things straight on each property.

I have a checklist form for each property. These are reviewed every other day, if not daily, to see if any tasks need to be completed for any of my properties.  Nothing gets checked off the checklist until it is completed.

Let’s look at the list below and then I will explain each item in more detail. This is the checklist I use:

Buying On An Option – Check List

Address: _______________________

Contact:________________________

Phone:   _______________________

Projected Starting Date:___________

• Create Owner Folder for this home
• Order pre-title work
• Check IRS/State tax liens
• Check if mortgage is up to date
• Check if property taxes are paid
• Draft all documents:
  • Rental Agreement/Lease
  • Sales Agreement
  • Option Agreement
  • Memorandum of Option
  • Affidavit of Liens
  • Bank Authorization
• Seller’s Disclosure
• Lead Based Paint Disclosure
• Get a key or access
• Get an inspection
• Advertise the home
• Set up utilities
• Water Reading (if city H₂O)
• Water Softener (if house is on a well /if so, is the system rented or owned?)
• Get insurance (liability)
• Owner’s proof of insurance – additional insured
• Review title work
• Sign all documents
• Record Memorandum of Option
• Set up auto-payments if paying mortgage payment
• Maintenance/Work to be completed (list work that needs to be done)

________________________________________________________________________

If you have several properties, keep them filed in order of which ones are projected to start first.   These are the ones where I would focus my attentions first.  I would also advertise them more heavily.

Fill out the information at the top of the checklist. The address of the property, owner(s) name and phone numbers (how you will reach them – if there are multiple numbers, put them all down), and when the option is projected to start.

1. Create an Owner Folder for this home – This is the left-tabbed green folder (think green for money!). I call this the Owner Folder. I set one up for each property I buy on an option, outright, subject to, etc. We will use right-tabbed red folders when we sell on an option later – to hold all of the tenant buyer information.

All of your contracts, memos, notes, surveys, title work, or anything regarding the home will go into this folder. This is strictly for the information with the seller and you now.  Nothing from you or the tenant buyer will go into this folder.  [Note: Just the tab part or the address is in red or green – not the folder]

2. Order pre-title work – This can also be called a “commitment for title”. It is not to be confused with title insurance. You cannot get title insurance on property you don’t own, but you do want to do any title research to see what, if anything, is on the title and if there are liens on the property.  If you order it from a title company or an attorney, it should only take 7-10 days, maybe less if you have a relationship with them.  You can also do it yourself if you are knowledgeable in your own state and county about what you need to research and where to research.

This is where you will make sure with a title company that the title is clear of judgments and liens.  Not only check the title liens but the state and IRS tax liens that might go against the person on title.  If I go down to my county courthouse to research John Jones on 123 Anystreet, I might only find a mortgage on title, because IRS information is kept at a separate location.  However, a title company will pull the information from all relevant sources to give you a complete picture.  If there are liens other than the seller’s mortgage, this would indicate the seller is not a good candidate for a lease option, but rather a subject-to deal, because this would be considered bad debt on the property.

Also, the title work would show all the owners of the property. It is very important to purchase the property from ALL owners of the property.  There are times when I have looked at the title work and seen “Joe and Sally” on the title when Joe had said he owned the property.  Joe forgot to mention that he divorced Sally. The problem with this situation is that Sally is still on the deed/title of the home.  Sally either has to get off title by deeding her interest to Joe or agree to all the terms of the lease option and sign the paperwork. Whoever is on deed/title must all sign.

I also recommend that married people have their spouse sign documents too.  In many states a married man must have his wife sign the deed in order to transfer title, even if she is not on the title, because of her dower rights.  I recommend that anyone who is married have their spouse sign my agreements.

3. Check IRS/State tax liens – Usually the pre-title work will show both of these, but if you are doing your own research make sure you check for both of these areas and ask the county and someone to help you confirm that the seller does not have any IRS or state tax liens against them. This was covered in #2, but I want to make this abundantly clear if you are doing your own investigating.

4. Check if the mortgage is up to date – The best information source for the mortgage is the   Many mortgage companies will give their seller a statement each month to show what has been paid, what is still owed, and if any payments are behind. If the seller does not have one, they will have to order a current account statement.  If taxes and insurance are escrowed in their monthly payment, then you will also know that those are current. A mortgage company would not let those go unpaid or be delinquent.  An escrowed payment is a payment that includes the taxes and insurance as part of the monthly payment.

5. Check if property taxes are paid – You can call your local county or state office where taxes are paid and get proof that taxes are current. Find out in your state or area how to confirm that ALL property taxes are current on a home. Call your local city assessor’s office and ask them about the home.  In some states any back taxes might be paid by the county and the city might not know if the taxes are paid are not, so confirm with the assessor and possibly other real estate investors in your area how you will know if they are up-to-date and paid.  You can also ask the seller to provide proof to you of a recent paid tax bill; however, that does not always mean that a tax bill from 2 years ago was paid. Find out and protect yourself.

6. Draft all the documents – the documents I listed above in the Buying on Options Checklist. There is a copy of each document on my Buying on Options on-line course.

Three Main Contracts for a Lease Option

To make a lease option work, three main agreements are needed. It is possible to roll all three into one or two contracts, but I like to keep all three separate to make it clean and clear.  It is most important to keep them separate when you sell on an option (explained in that chapter).

• The Option Agreement – On the selling side, the option agreement turns control of the property over to the optionee (you) without ownership. When I am doing a lease option, I sign an option with the seller and they give me control for a specified amount of time (usually 2-5 years) during which I will be trying to secure a tenant buyer for their home.

• The Rental Agreement – The rental agreement specifies how long I will rent their home and how much I will pay each month for the rental of their home. The rental payment will always go first to their mortgage company if any mortgage is due on the home, then to the owner if any rent is remaining. Examples:  If my rent is $1,200 per month and the mortgage payment is $1,300, then the mortgage company will get $1,200 from me and $100 from the owner.  If the mortgage payment is $1,200 then the mortgage company will get one check from me for $1,200.  If the mortgage payment is $1,100 then I will write one check to the mortgage company for $1,100 and one to the seller for $100.

The check to the mortgage company needs to always have the mortgage account number on the check so that it gets applied to the correct mortgage.  The owner could have two mortgages with the same mortgage company. You really want to protect this mortgage and make sure that this mortgage is getting paid; therefore, put the account number on the memo part of the check.

• The Sales Contract – This agreement sets the terms of the final sale. Again, there are two of these – one for my deal with the seller and one for my deal with the tenant buyer. The deal with the seller has a set sale price – and that price remains constant regardless of appreciation or even depreciation.  However it is always negotiable up front – i.e. – it could be set that the price is $150,000 if purchased within 2 years and $155,000 if purchased between years 2 and 5.  On the tenant side, the contract also has a solid number, and because you set the terms of the lease option, that price will be higher than the price you have with the seller.

Additional Forms For the Seller

There are other forms that the seller will need to sign.   They are:

• Memorandum of Option – This is the document that gets recorded against the title of the property. It does two things:
  • It gives the world notice that you have an interest in the property. It does what is called clouding the title.  When you cloud a title, the seller can’t refinance the home or sell the home to someone else and give clear title.  A reputable title insurance company would not insure it with this memorandum on the title.  It protects your interests in the property and is VERY important that it gets recorded.   Having it signed and notarized does you no good.  Recording it is a necessary step.

• It can season the title. Seasoning is a term that is becoming more and more important to real estate investors. Mortgage underwriters are the ones that approve mortgages, and are now becoming very strict on the length of time investors or sellers have owned properties before selling them.  There has been so much mortgage fraud in the past few years that the mortgage industry is really cracking down on this.  One way to prevent this type of fraud is to make sure that the seller of a home has owned it in their name for 90, 120, even 360 days. Each lender has their own requirements for the number of days to season a title of a property.  This becomes important for this strategy (lease option), as a lease option is not ownership.  You will be selling a home later that you did not own, but maybe for one hour or so.  This can cause a situation for you that needs another solution.  There are always solutions to almost any roadblock.

• Affidavit of Liens – This is a sworn statement that the seller signs disclosing all of the liens they have on the home. The mortgage should be the only lien; however, this is the sworn statement disclosing this. Also, it asks about liens that are not yet recorded but known about; for example, the roof was done last month, but the roofer was not paid yet, this could become a lien, or maybe they know it will be a lien. They must disclose it, or it would be considered fraud.
• Bank Authorization – This document is used to give you authorization to get information on the mortgage. You can find out at any time the status of the mortgage, balance, payment history, payoff amount, etc. It gives you authority to find out information with the mortgage company as if it was your mortgage.  All payments made in the future should be made directly to the mortgage company and not to the seller.  This is why you will want access to the seller’s mortgage information.  This will protect you from having this home go into foreclosure.
• Sellers Disclosure – A statement that is filled out that discloses the condition of the home. The seller must disclose any problems with the home. Each state has a different seller’s disclosure statement.  Ask a local RealtorÒ for a blank seller’s disclosure statement for your state.
• Lead Based Paint Disclosure– Don’t overlook this one because it seems obvious. It is a federal requirement on the sale or rental of any home. Prior to 1978 there was lead used in some paint products used in residential homes.

Lead poisoning has caused many problems for people, but primarily permanent damage to children. Because of these problems with lead based paints, HUD has passed a law that requires sellers and landlords to have the lead based paint disclosure signed and the pamphlet called “Protect Your Family From Lead in Your Home” to be given to all buyers and all tenants.  If this is not completed, the fines are significant.  Don’t miss this step!

Also, if you do have lead based paint in your home but you didn’t do this step and there is a problem discovered later, imagine how much the jury will hate you if a child is found to have brain damage from your negligence. The jury will give the child’s family a judgment award, which will take every dime you ever had, or will have.

Check out your states lead abatement requirements. Some states do require to you completely remove the lead based paint from your rental homes.  You may want to avoid those homes or confirm it has been completed prior to you taking it over.

7. Get a key to the house – You want to make sure that you have a key or accessibility to the home. If the home is listed through a RealtorÒ, you may be able to get the lockbox combination and have access to show the home any time if it is vacant. If the seller is still living in the home, which is often the case for me, then I want to make sure that I either have the ability to call the seller when I have a showing and/or that the seller gives me a key and I call them when I am going to be showing it.  If the seller will give you a key, you will want to consider a lockbox. You can purchase these at most hardware stores.

8. Advertise the house – Get the home advertised as soon as you know it has passed your inspection, perhaps even before (remember my Stupidest Move Award—you don’t want it sitting vacant!). You really want your time of vacancy to be minimal. Get it in the newspaper, with local employers, on a website, etc. Advertise anywhere you can find a buyer.

9. Set up the utilities – Do this when you are actually going to be taking possession of the property or the time frame is actually starting for taking possession of the property. For example, if it’s April 28, and I’m taking the property on May 1, I want to go ahead and turn on the utilities in my name. This is the electrical, water, gas, etc.  You will want to turn on anything that is required to be in your name and out of the seller’s name.

Be especially careful for winter months in cold parts of the country. You will not want any days to go by without heat.  I have had ice skating rinks in a few of my homes over the years because the heat was not turned on.  See why I do my checklists? J

• Water Reading: You also want to do a final water reading. In some cities and municipalities, water can be a lien against the home if not paid, so you want to make sure it’s current and paid from the day that you take possession from the seller.  Also, have the water bill mailed directly to you. This way you can pay it and bill the tenant or you can bill the tenant and know that it is getting paid.  You do not want a lien to accrue on the home.

• Water Softener: If there is a water softener on the property, you want to make sure you are taking care of that.  If it’s a rented softener unit, you want to make sure you turn that contract into your name.  I have a water softener company that I work with, and I will set up a lease to own on the softener equipment. The tenant actually pays the bill, and if the tenant(s) end up not exercising, then at the end of their lease the water softener belongs to me.  Having a water softener is critical if you have hard water.  If you have city water, most likely you will not need a water softener.

10. Get Liability Insurance – You’re not going to insure the property itself, but you’ll want to carry liability insurance that will cover you for doing these types of transactions. Since you don’t own the home, you can’t actually insure the home.  However, you have a liability issue just by being the landlord of the home.  As far as the tenant is concerned, YOU are the landlord, and as far as the owner is concerned, YOU are the tenant.  You have both tenant and landlord “roles” when you don’t even own the property, so I recommend some type of commercial general liability policy that would cover you for properties you don’t own.

This is not going to be a make or break on your first deal or two, but something you will need to consider for this business.  Talk to an insurance agent to get educated, but do get several opinions and quotes. Some will try to over-insure you and sell you more insurance than you need.

11. Owners Proof of Insurance – Make sure the owner has insurance on the home itself. If they have a mortgage, the mortgage company will require it, but if they own it free and clear, they may not have insurance.  You will also want to make sure that they name you as an additional insured on the insurance policy.  Some insurance companies will not want to put you on their policy without you being an actual lien holder (like a mortgage holder- see the advanced strategies chapter for an idea here).

My rental agreement and my sales agreement require my owner to put me as an additional insured on their homeowner’s policy.  They might have to switch insurance companies to find an insurance company that will do this. There are several benefits when being an additional insured:

1) You do get liability protection

2) You should get notified if the seller cancels their insurance policy for any reason, even non-payment, and

3) You probably will be on any settlement check if the home burned down. Being an additional insured is a great thing, but should not usually be a deal breaker.

12. Review the title work when it comes back – Check for liens and for ownership. Make sure it’s clean and clear from what you were expecting. You will want no surprises. Do understand, however, that there are things that do show up on the title work that can be an error. I have had several show up with old mortgages on them, but you won’t know until you ask the owner. It appears as if the owner has two mortgages.  Don’t assume they didn’t tell you or that they are hiding something, ask them about the mortgages showing on the title work.  Many times the owner had refinanced the home and the old mortgage didn’t get discharged properly.  Don’t be alarmed, just get the old one cleared up.  The title company can help you with all of this.

13. Make sure all of the documents are signed by the seller and you – Have 2 complete, signed sets: one for them and one for you.

14. Record the Memorandum of Option – This document is usually recorded at the county office. Once you are certain that you are going to move forward with the deal, if you’ve got a start date coming up or if you’ve got a buyer in the property, then you want to record the memorandum of option.  This will get recorded against the title – it shows the world that you have a claim against the property and that you have the right to buy it on an option. This document is filed at the county where the seller’s home resides, or wherever you record a deed.

15. Set up the payments with the seller – You can set up an automatic payment with the Mortgage Company that goes directly out of your bank account. I use QuickBooks and it will set up automatic payments so that you don’t forget to write the checks out in a timely fashion.

16. A list of maintenance or work to be completed before I take possession – This is a list that either you or the seller are responsible for, depending on what deal you have made with the seller (e.g., replace linoleum, repaint trim, replace mailbox). All repairs are to be done by my contractors (so I can control the quality) unless otherwise specified. All repairs, both major and minor, are the responsibility of the tenant except for the first 60 days of the agreement – I leave that responsibility to the owner. For instance, if the furnace were to go out two days after I took possession, I don’t want to be responsible for that. Now, everything is negotiable; 60 days is just my standard. You can make it longer, you can make the seller responsible for all repairs, for anything over/under $500, nothing at all, etc.

 Some of My Favorite Clauses for the Three Main Lease Option Contracts

In each state you may have required information for your rental agreements and purchase agreements. I offer contracts on my website that are generic and can be used in all states, but your contracts should always be checked by a local attorney as each state has its own unique laws.

Therefore, you should to get the advice of an attorney. Attorneys can be very expensive; therefore, I recommend some of the best attorneys – and most reasonable – through Pre-Paid Legal Services.  You can find out more here, but as a quick introduction, it offers plans at very reasonable monthly rates that give you legal assistance.  I have been a customer since 1997 and have saved thousands of dollars on legal questions, contract reviews, letters, etc. for real estate matters and in multiple states.

Each state has its own rules and regulations regarding rentals, lead based paint abatement, evictions, etc. Here are some of the clauses that have been my favorite over the years in my contracts to buy on lease options.  Depending on what you have negotiated with your seller, you may want to use these clauses, and they may or may not always apply.  They are just some examples of things I have used with my sellers:

The Option Agreement

• There shall be an additional option consideration of $_____ per month given by Optionor to Optionee as credit towards purchasing the home.
• Optionee has the right to multiple-list, advertise, or resale this property before or during the option period.
• Should the property become uninhabitable at any point during the lease period the tenant will be released from all rent liabilities until the property is habitable and is re-let. The amount of time that the home is uninhabitable will be the time period that will be added to the option agreement and attached rental agreement and offer to purchase.

The Rental Agreement (Lease)

• Tenant will have access to the home on ____ to show the property to prospective tenant/buyers and contractors.
• Tenant will be assigning this agreement to anther party, but is still responsible to the owner per this agreement
• The owner gives the tenant the right to make repairs/improvements to the property at the tenant’s expense. All repairs and improvements will be done with the tenant’s contractors.
• Landlord agrees to use his/her homeowner’s insurance to cover any items/repairs/damage that would be covered under their policy (i.e. storm damage, fire, etc) – since tenant can’t utilize their insurance for these types of repairs.

The Sales Contract 

• Purchaser will put $_____ down on this property. Check will be written directly to: Realty company of listing office upon execution of the attached rental agreement. This amount will be applied directly to the purchase price at closing, and any listing commission owing. The remaining commission, if any, will be paid at closing out of seller’s proceeds to the appropriate offices.
• Seller agrees to change his/her homeowners insurance policy to a non-owner-occupied policy and to name the purchaser as an additional insured within 3 days of purchaser taking possession of the home.

The paperwork is vital to your successful ability to make a lease option deal, so don’t skip any steps, and make sure all areas of the checklist are covered.  You will add your own favorites over the years that you do lease options and learn new ideas.