When you are buying a house on a lease option, you must protect yourself from paying your rent payment to the seller, but him not paying the lender.
The single best way to protect yourself is for you to pay your payment directly to the LENDER so that you are certain that the payments are kept current. Many sellers will be okay with this, although many sellers won’t.
Pay the lender directly
Whenever possible, this is how I handle my own lease option properties. Currently for about 30% of my houses I pay the lender directly.
In many cases, I started off paying the seller directly, but after a little bit of time had passed, and I built up trust in the relationship, I ask the sellers if I can just send the payment to the lender directly.
Note: One very powerful way I build trust in the relationship is that I pay my sellers EARLY! I mail checks out on the 25th of each month. You would be amazed at how this small gesture impacts your relationship with the seller.
Option two is for you to set up an escrow account you pay your monthly payments into, and for this escrow company to pay the lender each month (and notifying the seller and you that they have done so.)
I don’t use this method because it’s too complicated for my thinking. Variations on this theme are to send the seller a check made payable to the lender in the amount of the mortgage payment with a pre-addressed and stamped envelope to let the seller quickly forward the check on to the lender.
This allows the seller to feel confident that the payments are coming in, and lets you know that the payment has been made (by checking to see if the check has cleared.) Instead, if I can’t pay the lender directly, I simply pay the seller and let them pay the lender. How do I know the payments are being made?
I get the seller to sign two specific documents up front (in addition to the performance mortgage or deed of trust and all the other closing paperwork we escrow on the front end of any lease option deal.)
Document one: Authorization to Release Information
This gives me the ability to talk with the lender about any of their loans. I can even check every few months that the payments are current by calling into the lender’s touch tone phone hotline and entering in the seller’s loan number and social security number!
Document two: Authorization for Direct Payments
This gives me the right to pay any third party that is owed money by the seller that the seller hasn’t paid who could place a lien on the property, and to count this money as money paid by me to the seller under my lease option agreement. This includes mortgage payments, property tax payments, etc.
Here’s part of the agreement we use when buying on a lease option. See if you can find the powerful incentive we give the seller to make sure he does in fact make his payments with the money we send him:
“If the mortgage payments, property taxes, association fees, insurance premiums, or other property payments on __________________________ ever go into arrears, then ________________________________ (Landlord) hereby gives_______________________________ (Tenant) or his/her/its assigns or heirs the right to make payments directly to the lender or other party who is owed payment on Landlord’s behalf.
These payments sent directly to the lender or these other parties by the Tenant shall be considered as rent (or other money due) received by Landlord from Tenant for compliance of Residential Lease Purchase Agreement between these parties dated _________________.
To adequately compensate the Tenant for the additional risk incurred by making such payments of additional rents and costs, for every one dollar ($1) paid to lender or other parties to make up late payment(s) and/or fee, premiums, etc., three dollars ($3) shall be credited off the option price stated in the Residential Lease Purchase Agreement of December __________________.
Once these payments/fees are made current, Tenant may make his or her payments directly to the Lender and other parties for the remainder of the lease period state in the Residential Lease Purchase Agreement dated on ______________ between _____________________________ (Tenant) and ____________________________ (Landlord).
These continuing payments sent directly to the lender or these other parties shall be considered as rent (or other money due) received by Landlord for compliance of Residential Lease Purchase Agreement between these parties dated on ___________________, but shall not be credited with the three for one credit detailed above.”