This post was last updated on July 12th, 2021 at 08:23 pm
In real estate an Option Agreement is a type of Purchase Agreement. An Option Agreement gives a potential buyer the right, but not the obligation, to purchase a house.
The Option Agreement says the buyer can buy a house for a certain amount of time, at a certain price and on certain terms. This is very similar to other Options Agreements such as Stock Options. A key feature of an Option Agreement is that a buyer CAN buy a house. But they don’t HAVE to buy the house.
What Does An Option Agreement Contain?
A well written option agreement will contain at the minimum:
- An expiration date
- A Purchase Price
- The Premium paid for the Option
- Description of the Asset or Property
Expiration Date Of An Option
A good Option Agreement should clearly state the date the Option expires. The expiration date of the Option is the date by which the buyer has to notify the seller whether or not they plan to execute, or use, the Option.
The transaction does not have to be completed by the expiration date. The expiration date is simply the date by which the buyer must notify the seller of their intent to move forward. If the expiration date passes without Execution the option is no good. This is called Option Expiration.
Using Option Agreements Can Be Dangerous
I recently saw an Option Agreement that had no expiration date! A friend of mine purchased it. He now has the right to buy a certain house at a certain price anytime he chooses!
The option has no expiration date. By failing to put an expiration date the seller gave him an option that may never end. This is one very important reason to be sure that an Option Agreement has a clear expiration date!
Purchase Or Strike Price Of An Option
When we talk about Options Agreements the proper term for purchase price is the Strike Price. The price which the house can be purchased. It’s the same thing.
The purchase price, like other aspects of an Option Agreement, are negotiated between the buyer and seller. This is the price that the buyer must pay to be able to buy the house.
If the buyer is not willing to pay the purchase price then the Option Agreement is not likely to get executed. Setting a Strike Price too high can make it very hard to sell an Option Agreement. Few buyers are willing to buy an Option they know they can’t execute.
What Is An Option Premium
When using Options a Premium is the amount that the buyer pays the seller for the rights they are receiving. The seller gets to keep this Premium even if the Option doesn’t get exercised or expires.
The seller is giving the buyer rights to buy the property at a certain price for a certain amount of time. The Premium is what the seller receives for doing this. There is no set Premium that an Option Agreement must have.
It can be as little as a few dollars or as much as several million! The Premium, like most aspects of an Option, is negotiated between the buyer and seller.
What Type Of Property Description Does An Option Contain
An Option Agreement can contain any type of property description that the buyer and seller are comfortable with. It can be something as simple as the address to a house. Sometimes it can be a complicated legal description for a property. It depends on the type, size and value of the property.
As long as the description can accurately describe the property (and makes both the buyer and seller feel comfortable) the property description can be written any way you like.
What Are Option Agreements Used For
Now we know a little about what a basic Option Agreement contains. Next lets look at what they can be used for.
Basic Option Agreement Example
Let’s say Sam has 20 acres of undeveloped land by the highway. Tom thinks that the area by the highway will soon be used for commercial development. Sam will sell the property for $500,000. Tom thinks the property is worth about $200,000.
Tom and Sam agree to use an Option Agreement. Sam is willing to sell the property to Tom for $500,000 any time in the next 2 years. They agree that Tom will pay Sam a $5,000 premium for the Option. Sam gets to keep the $5,000 premium even if Tom doesn’t end up executing the option.
About 6 months later the area by the highway starts being developed for commercial use and starts selling for over $100,000 per acre. Tom tells Sam he would like to execute the Option and they move forward with the transaction. Tom would then pay Sam $500,000 for the 20 acres.
This is a bit of an extreme example but it shows why an Option Agreement can be a good idea in certain situations. If Tom had been wrong and the land had not suddenly gone up in value he could have just let the Option expire in which case he would have only been out the premium he paid.
What Is The Most Common Real Estate Option
Options are not uncommon in real estate. We see them most when we look at Lease Options. Lease Options combined a residential lease with a purchase Option Agreement.
It’s often said that 99% of Options expire and become worthless. While some sources say that the number is much lower they usually only look at Stock Options. Most Options, especially those that are part of a Lease Option, do indeed expire and become worthless.
Should I Use An Option Agreement To Buy Or Sell A House?
Option Agreements can be very powerful. They can also be very dangerous. Most people simply don’t understand Option Agreements. You should never use a tool you don’t know how to use.
I’ve seen a lot of landlords and tenants both have issues with Option Agreements. Landlords want to make more money but end up with legal issues. This is normally because they don’t understand what they are offering their tenants.
Sometimes it’s the tenant that loses out. I’ve met many tenants who thought they were getting more than they understood. They spend a lot of money for an Option Agreement that was never going to be executable.
Does 181-Close-Now Use Option Agreements?
The job of a Closing Options Analyst for 181-Close-Now is to find a closing solution that fits your need. 181-Close-Now prefers to use a Purchase Agreement. But if it helps a client we will consider using an Option Agreement in certain circumstances.
We have a rule when using an Option Agreement. Our Closing Options Analyst will go over the agreement with you in detail. We make absolutely sure that out clients understand what an Option Agreement is. You’ll know what it is and why it best fits your situation!
Unlike other companies that buy houses in Oklahoma 181-Close-Now always keeps you informed! See the 181-Close-Now difference for yourself.
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