Texas Lease Option - Is it Legal?

Many questions arise when the strategy of Lease Options, Lease Purchase or Rent To Own (here after referred to as LO) are discussed for Texas residential real estate. The biggest question is:

"Is it Legal?" - Yes.

I am not a lawyer, but I can read and comprehend. This posting is my interpretation of the Texas Property Code as it relates to Lease Options in Texas.

LOs are discussed in Chapter 5 of the Texas Property Code, Subchapter D Executory Contract for Conveyance.

The first thing to point out is that the law only applies to residential real estate that is used as a purchaser's residence.

Secondly the Law applies to Options to purchase real property that includes or was executed with a residential lease agreement. Some people may interpret this and state that if the Lease Agreement and Option to Purchase agreement are kept separate from one another, this law does not apply. I interpret this as:

if you are leasing a property and the tenant has an option to purchase the property, this law applies.

An LO contract of 3 Years or less has fewer restrictions than an LO over 3 years in length. Something to point out, if the parties to the LO contract of 3 years or less, extend the contract past 3 years, the contract is now subject to the more stringent LO law. see law

LO's of 3 Years of Less

Here are the subsections on the Texas Property Code that apply to LOs of 3 years or less:

1. Sections 5.063-5.065
2. Section 5.073, except for Section 5.073(a)(2);
3. Sections 5.083 and 5.085.

Sections 5.063 - 5.065: Default by Purchaser and the Rules that apply.

5.063 Details the rules a Seller must follow when a Purchaser is in default of the LO agreement. An example of this would be a purchaser that has not made a monthly payment.

5.064 States that a Seller may cancel an LO agreement or accelerate the funds due when a Purchaser is in Default.

Example: Purchaser has not made their monthly payment. Seller has sent Notice to Purchaser detailing the Seller's intent to cancel the agreement if funds are not paid. Purchaser fails to make monthly payment within 30 days of the date Notice was given. Seller cancels the LO agreement and keeps the Purchaser's Option Fee.

5.065 Details the Purchaser's right to cure a default of the LO agreement. A Purchaser has 30 days from the date Notice was served to take the necessary actions to cure their default.

Example: Purchaser in the previous example receives Notice from the Seller that they intend to cancel the LO if payment is not made. Purchaser pays the past due amount, and any late fees, to bring their account current within 30 days of the date Notice was sent.

Section 5.073: Contract Terms of the LO agreement
This section details terms of the LO agreement that must be included.

1. Late Fees: Late fees cannot exceed the lesser of 8% of the monthly payment or the actual cost to administer the late fee.
2. A pre-payment fee or penalty is not allowed.
3. Forfeiture of the Option Fee or Option Payments for Late Payments are not allowed. A Purchaser that is in Default of the LO agreement may have their Option Fee and Option Payments forfeited.
4. A Seller cannot increase to the purchase price, option fee, or option payments in response to a Purchasers request for repairs.

Section 5.083: Purchaser's Right to cancel LO Agreement for Improper Platting

If the Property was platted incorrectly, the Purchaser may cancel the agreement. An example would be the Property was not subdivided correctly by the Seller.

Section 5.085: Fee Simple Title and Maintenance of Title

This, in my opinion, is the most laborious and restrictive Section in the Law. This section details the items a Seller must do to keep the Purchaser informed if there is a Lien on the Property. In most instances, a Seller entering into a LO agreement will have a mortgage or deed of trust on the property. If the Seller does, the following must be done to stay compliant with the Law:

1. Within 3 days of entering into an LO agreement, the seller must disclose to the Purchaser a. the Name, address and phone number of the Lien holder
   b. The loan number and current balance of the loan
   c. the monthly payments and their due date.
   d. Disclose that if the Seller fails to make payments, the Lien holder has the right to Foreclose on the property.
   
2. The Seller must maintain the loan balance at or below the current amount due by the Purchaser.
3. The Lien holder must allow Lease Options and will allow payments from the Purchaser if the Seller defaults on the loan
4. Covenants are required to be included in the LO agreement. They are as follows:
   
   (i) a covenant that obligates the seller to make timely payments on the loan and to give monthly statements to the purchaser reflecting the amount paid to the lien holder, the date the lien holder receives the payment
   (ii) a covenant that obligates the seller to notify the purchaser in writing that the seller has been sent a notice of default, notice of acceleration, or notice of foreclosure or has been sued in connection with a lien on the property and to attach a copy of all related documents received to the written notice; and
   (iii) a covenant that warrants that if the seller does not make timely payments on the loan or any other indebtedness secured by the property, the purchaser may, without notice, cure any deficiency with a lien holder directly and deduct from the total outstanding balance owed by the purchaser under the executory contract, without the necessity of judicial action, 150 percent of any amount paid to the lien holder.

Conclusion:

Lease Options are legal in the State of Texas. LO agreements in Texas require additional Covenants, disclosures, and monthly administration than in other states, but they are definitely not illegal.

My advice, discuss the Law with a competent real estate attorney before offering a property for sale on a Lease Option contract.