Lessons Learned From a Lease-Option

The portable phone was crammed between my shoulder and aching neck. I was changing the twins’ dirty diapers and wailing to my friend: “We could lose our $11,000, lose our dream house and have to move the whole family in a month. Agh!”

We had made every conceivable mistake when we signed a lease-option agreement the year before and we were about to pay a steep price. In the spring of 1992, we seemed the perfect couple to benefit from a lease-option agreement. We were expecting our two babies, so we needed to get out of our tiny rented condo. My husband had recently changed careers to become an assistant director and his track record as a free-lancer wasn’t long enough to qualify for a mortgage. Lease-option would get us into a house right away and give us the extra year we needed to qualify.

The terms of the deal would also help us add to our down payment. The $5,000 we paid for the option to buy would be credited toward the down. We paid $2,000 a month in rent and $500 of that would also be credited. So after a year, we’d already have $11,000 toward the down.

So how did we go wrong? Let me count the ways. First, we didn’t research the market. After renting on Los Angeles’ Westside, $2,000 a month looked like a steal for a house with five bedrooms and two baths. But here in Calabasas, $1,500 would have been market rate. The extra $500 a month was just an enforced savings program, not a real return of rent value.

Then we really blew it. In a declining market, we set the purchase price of the house a year in advance. Dumb, dumb, dumb. Although we realized that prices were going down, we didn’t know how far they would nose dive. We trusted the owner when he said the house had been appraised at $313,000, so in a year $290,000 would be reasonable. (Repeat here: Trust, no. Buyer beware, yes.)

Come January of this year, we knew the house wasn’t worth $290,000. Our owner wouldn’t admit it, so we had the house appraised. The appraisal came in at $268,000. We should have been happy, but we weren’t. We had painted ourselves into a scary corner.

No lender would approve a mortgage on a purchase price of $290,000 when the house was worth $268,000. But if we reneged on the agreed price, we forfeited our option. The owner could keep our $11,000 and sell the house to someone else.

This was heartbreaking for me, because I had fallen in love with the house. The gorgeous rural views that drew me there were now part of my life. I enjoyed the Malibu Canyon from my kitchen sink, and rolling oak-dotted hills from the back yard deck. At night I would step outside for a moment of twinkling stars in darkness and privacy.

The house itself was nowhere near so lovely, the tract having been built in 1965. But the layout was practical for us and it had great fix-up potential.

A couple of deadlines increased our desperation. The TV show my husband worked on would end its season’s production in late March. It would be hard to get a mortgage (or even a rental place) if Bob didn’t get other work right away. Also, we discovered a provision of our lease-option agreement we hadn’t noticed before: If we didn’t exercise the option by the one-year date, our rent to stay there doubled. (Yes, we were ninnies not to notice.)

Luckily for us, our mortgage broker came to the rescue. With great difficulty, she convinced us that it was futile to try and come up with $290,000, no matter how much I loved the house. And she gave me the expertise and support I needed to negotiate with the owner.

I was at a gross disadvantage. The owner, a.k.a. “Evil Landlord,” was himself a mortgage broker and continually tried to snow me with technical jargon. Also, I am not a good liar. I knew I couldn’t bluff enough to persuade him I was willing to walk away from the deal. (In negotiations, the power to walk away is your real power. Paying for an expensive option, falling in love with the place and dreading another move divested us of a lot of that power.) The smartest thing I did was to insist on conducting all negotiations in writing.

Our mortgage broker always called at the worst possible times, when I was feeding or changing both babies. I would be up to my wrists in sweet potatoes or dirty diapers, shouldering the phone, taking mental notes as she told me what to say.

Basically, I stated and restated the facts: a bad market had driven the value of the house down, I couldn’t get more than $268,000 to buy it and no one else would pay any more. Of course, being so enamored of the house, I was sure there were folks lined up to pay $290,000 for it. And having agreed to pay $290,000, I felt the owner had the right to charge us that much or keep our $11,000.

The weeks dragged by as he took his time responding to my letters. In his first letter, he agreed to come down from $290,000 to $279,000 but said that was his final price. We stood firm, but Bob’s last day on the job was approaching fast. I looked at other houses and found nothing else that I liked as well. With only three weeks of work left, we were really sweating.

Then the owner sent us the letter we’d been waiting for, agreeing to sell for the appraised value. And even though we had broken the contract, we’d still get our $11,000 credit.

It’s a textbook case of bungling, but our story has a happy ending. We got the house we wanted, for a reasonable price, and didn’t lose our investment. We know we will enjoy living here because we have already “tried out” the neighborhood and the house. (We know the roof can withstand a seven-year rain.)

I might recommend lease-option to someone in a situation similar to ours: needing a house now, but more time to save a down payment or establish a job or credit record. But if I were to do it over, I would protect myself in so many ways: get comps on nearby sales and rentals first, agree to pay only appraised value at the time of sale, try to pay less for the option and get back more in rent credits.

And, (how do you do this?), don’t fall in love with the house.