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Lease-option contracts come with risk

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POSTED March 8, 2012 7:20 p.m.

DEAR BENNY: In a recent column you mentioned a renter who has a lease with an option to purchase the property and who makes his rent payments as agreed, but the property owner has not been paying the mortgage and is heading towards foreclosure.

Most appropriately executed lease-option contracts include a nonrefundable option amount, plus a negotiated portion of the monthly rent is held in trust for the lessee’s future down payment. This renter may be getting “ripped off” if he will lose his option payment (through no fault of his own, which may or may not be applied to a future down payment) and if any portion of his rent is to be held for a future down payment. If this is the case, would he have a small claims case against the owner? --Maggie

DEAR MAGGIE: You make a good point that the portion of the rent that was to be used for the purchase price should have been put in trust (or escrow). However, quite often the property owner and the potential tenant (purchaser) just get together and draw up some kind of legal document without the advice or involvement of an attorney.

Does the tenant who may now lose a portion of the deposit have a case to bring? First, I subscribe to the concept that “there is no cash register at the back of the courthouse.” In other words, you may get a great judgment, but can you collect it especially when the landlord can’t even manage his monthly mortgage payment?

Second, while it is true that a portion of the monthly rent was to be used as a deposit to buy the property, a judge might very well take the position that the renter was simply paying to live in the property. Even though he was unable to purchase, the moneys being paid monthly were also rent, and the renter got his money’s worth. Of course, if the renter’s monthly payment exceeded the fair market rental in his area, that would change the situation.

DEAR BENNY: Often lease options require substantial deposits larger than an ordinary security deposit. They can also require the tenant/potential buyers to pay a higher monthly rent for which a portion will be a credit at the time they exercise their option. If I were the tenant, I would be quite upset under those circumstances. --Becky

DEAR BECKY: As I just responded above to another reader, not everyone has an experienced real estate agent or an attorney, and not all lease-option arrangements include higher deposits or larger rentals. In fact, many landlord-tenant laws throughout the country restrict the amount of the security deposit. For example, in the District of Columbia where I practice law, a landlord can take only a one-month security deposit.

By the way, for the benefit of my readers, a lease with an option to purchase is a procedure whereby a tenant expresses interest in buying a house (or condo) but currently (for one reason or another) is unable or unwilling to buy. So the tenant agrees to lease the property for a period of time, with a written option to buy, usually at a specific time in the future.

As my readers suggested above, a good lease with an option to purchase will require the tenant to pay a little larger security deposit (if allowed by state law) and a rental amount that is higher than market. The difference in the rent should go into escrow to be used as the earnest money deposit on the house.

But it doesn’t always work that way. In today’s market, often the tenant is in the driver’s seat, and can dictate the terms and conditions to the landlord who is anxious to get some cash and move on with his or her life.

DEAR BENNY: What are your thoughts on donating a time share? It seems like a good option, as the owner would get a tax deduction for the donation and an organization would benefit. Also, it seems the issue of affecting a credit rating wouldn’t come into play. --Carol

DEAR CAROL: You’ve no doubt heard the expression, “It takes two to tango.” Yes, you can donate your time share, but only if the donee is willing to accept it. Several years ago I suggested that consumers donate their time share to their church or synagogue. Shortly thereafter, I received an urgent email from a priest asking me not to make that suggestion again; the church did not want the time share and did not know what to do with it.

And, if you still owe money to the time-share developer, you are saddling the charity with that obligation. Additionally, even if no money is owed, every time share charges a monthly/quarterly/yearly fee for administrative expenses. That, too, will have to be paid by the charity.

Obviously, if you can find a charity willing to accept your donation, more power to you. I am not too optimistic, however.

DEAR BENNY: I recently heard that some organization is doing independent reviews of foreclosures to determine if errors were made. Do you know anything about this? --Tim

DEAR TIM: Yes, the Federal Reserve board of governors and the Office of the Comptroller of the Currency have required an independent foreclosure review by an independent consultant. The purpose of the review is to identify eligible homeowners who may have been financially injured due to errors, misrepresentations or other deficiencies in the foreclosure process. If the review determines that there was financial injury, the homeowner (or former homeowner) may be entitled to receive compensation or other remedy.

To qualify for this review, your loan must meet the initial eligibility criteria:

(1) Your mortgage loan must have been serviced by one of the participating mortgage servicers;

(2) Your loan must have been active in the foreclosure process between Jan. 1, 2009, and Dec. 31, 2010; and

(3) The property was your primary residence.

For more information, search “independent foreclosure review” on the Web, and click on the Federal Reserve website. There you will find the list of participating mortgage servicers.

Please note that to participate in this review, you must complete a form and have it postmarked no later than April 30, 2012.

DEAR BENNY: I read your article today regarding a management fee being charged on a security deposit. I agree with you that a fee should not be charged on a deposit that is used to repair damage on an apartment or house. However, I disagree that a fee should not be taken when the security deposit is used as the last month’s rent. In that case, the deposit becomes rent and a fee is due. --Joe

DEAR JOE: I must respectfully disagree. Most leases specifically state that the security deposit shall not be used for the last month’s rent. Unfortunately, many tenants ignore this, and walk out at the end of the term without paying the last month’s rent.

Yes, the landlord will use that deposit, but it is not “rent.” Typically, it is used to clean up from the last tenant, make repairs that the tenant caused, etc.

However, if the property manager specifically wants a fee based on that security deposit, it should be spelled out in the management contract agreement entered into before there are any tenants. So long as there is full disclosure, and the landlord understands the terms and conditions of the management company’s fee structure, that is acceptable.

DEAR READERS: Do you have to repay the First-Time Homebuyer Credit? If you bought a home in 2008, and claimed that credit, it is treated as a no-interest loan that must be repaid in 15 equal annual installments. The first installment was to have been paid when you filed your 2010 tax return.

The IRS has announced that it will no longer send reminder letters to taxpayers. However, there is now an online lookup tool to check and determine your repayment obligation.

You can access the First-Time Homebuyer Credit Lookup Tool 24 hours a day, seven days a week, by visiting www.irs.gov/newsroom/article/0,,id=253206,00.html.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.

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