An option to purchase (OTP) is a unilateral contract entered into by a property seller and a potential buyer, where the former is obligated to sell and the latter not obligated to buy.
A small sum of consideration, sometimes called a booking fee, is paid by the potential buyer for the seller (homeowner) to issue the OTP.
This is in essence, the fee to purchase the exclusive right to buy the property in question.
The OTP would state important information including:
- Legal name of buyer and seller
- Address of property
- Purchase price
- Booking fee
- Active period of OTP
- etc
The active period would usually be indicated by a specific date in the future, or how long the option remain active from the date of issuance.
Should the potential buyer fail to exercise the option within the active period, the homeowner keeps the booking fee and becomes free to sell to any other parties.
Should the option be exercised, the date of execution is stated and the transaction moves on to the next stage of the buying process.
At this point a sale and purchase agreement (S&P) is signed by both parties in which both are obligated to complete the transaction.
It’s not uncommon for buyers to allow option periods to lapse due to economic events as he feels that the price of a house should be substantially lower than the previously agreed transaction price.
It should be noted that at the stage of OTP issuance, the home owner is obligated to sell while the home buyer is not obligated to buy.
This means that the power lies with the buyer and the only leverage the seller has is the booking money.
However, sellers also sometimes breach the terms of an OTP by selling the house to someone else during the active period of the option.
In this case, the seller might be sued for damages. And a court might even order that the property be rightfully sold to the option holder instead.
OTP and mortgages
While a lender might be able to offer a home buyer an in-principle approval for a home loan, there is no official offer on the table.
This is because everything is just hypothetical at this phase and there is no real property to buy.
This changes when the OTP, or S&P is submitted to the lender.
With the option-to-purchase, the mortgage application can proceed to the credit and underwriting departments of the bank to conduct proper credit analysis.
Upon approval of the home loan, an official letter of offer would be delivered to the homebuyer/borrower for review and acceptance.
This loan facility letter will be an important piece of document to prove that financing is ready at closing so that all closing procedures can proceed. There can be no closing when there is no financing.
Lease option
A lease option is a different for of option to purchase that arise under different circumstances.
But it still holds the same principles of a regular OTP.
Lease options are basically tenancy agreements or lease contracts that grant the lessee the right to purchase the rental property outright at a specified price within a specified period of time.
This is a more subtle way that property owners and landlords use to their real estate assets.
Tenants would be able to live in the property for a period of time and might eventually find that the condition of the house, proximity to amenities, ease of transport, etc, ideal in meeting his needs.
He might also get more emotionally attached to the property and desire to buy it instead of rent it.
And it would be an easier purchase to make when the option to purchase the house, in the form of a lease option, is already inserted into the tenancy agreement.
To make it even more attractive for tenants to become buyers, lease option contracts usually allow the rental that has been paid by the tenants to be offset against the purchase price.
This means that if a house has a transaction price set as $400,000, and the first year rental amounts to $24,000, then the rental would be deducted from the sale price. Resulting in a balance of $376,000.
All in all, lease options can be very attractive clauses to activate when tenants like the property that they have been renting.
In addition, the mortgage installments would very likely be less than the rental amount which they would have to pay should they continue to rent.
So the tenant gets better cash flow, and owns the house.
The cash flow improvement can be even better when we factor in the use of CPF to service the mortgage debt.
Sub-sales
At the height of the property boom, investors looking for quick profits were known to secure OTPs from sellers and developers, and in turn sell the options to other interested buyers at a premium.
In essence, the investor is buying the “right to buy” the property and selling this “right to buy” to another buyer.
For such transactions to take place, the option to purchase must be assignable to another party.
If not, good luck trying to convince the seller to issue another OTP.
