Rent-to-Own: What You Need to Know

Posted by under Buying a Home

You might have heard about Toronto condos or houses being sold on a rent-to-own basis and wondered what was involved – what would be the advantages or disadvantages of buying or selling a home in such a manner?

There are good reasons why both a home buyer and a homeowner might be interested in getting involved in a rent-to-own arrangement, but it’s critical to protect yourself and to understand the process before you decide to buy or sell through a rent-to-own contract.

The Basics of Rent-to-Own

The rent-to-own concept is particularly attractive to home buyers who don’t have the minimum 5 per cent down payment saved up or don’t currently have a high enough credit score in order to qualify for a mortgage. Rather than buy a home outright now, a tenant/buyer would enter into a rent-to-own agreement which would give them the option to purchase the home at the end of the agreement for a particular price.

Usually, that time is around two or three years in the future and the price is often a premium of what you might pay today to reflect inflation and real estate appreciation. To get that purchase option, you have to pay a fee which is usually 2 per cent or 2.5 per cent of the final purchase price.

To give an example, if you were interested in buying a house via a rent-to-own arrangement that was currently on the market for $275,000, you might purchase an option to buy that house for $300,000 in three years. The cost of that option would be 2.5 per cent of $300,000 – which would be $7,500. You would then pay rent normally like you would in any normal lease, but add an additional amount every month that would go towards that purchase price. At the end of the contract, you would have paid the equivalent of a $15,000 down payment, or 5 per cent of the purchase price.

At this point, the tenant will have had time to improve their credit score, which could help them qualify for a mortgage and then purchase the home.

The Benefits for the Tenant

If you don’t have great credit or enough money saved for a down payment, then this is one way to help you save money to put towards buying a home and give you time to improve your credit. It also allows you a chance to see if you like the neighbourhood before buying.

Another benefit is that if the market value of the home goes up more than expected, you would still be able to buy it for the amount previously agreed on – an attractive proposition in the hot Toronto real estate market, for example. If it goes down, you do not have to purchase the property.

The Benefits for the Landlord

There are many reasons why a landlord might choose to sell their house via rent-to-own rather than in a straight sale. One advantage is that tenants will typically treat the home as if it was theirs – which means that they’ll take better care of it. Another benefit is that the amount of money you make is fixed and so even if the market value goes down, you can potentially still sell it for that amount. Even if the sale does not go through, you will have gotten the option payment and several years of rent payments from tenants who took good care of the home.

The Downsides of Rent-to-Own

While rent-to-own agreements can work well, there are a number of downsides. If a tenant is unable to purchase the property, that usually means that they will not get back their option payment. There are a number reasons why a tenant might decide not to buy the place; perhaps they realized they didn’t like the neighborhood, the house decreased in price, or maybe they were unable to get financing even with a 5 per cent down payment.

For a landlord, rent-to-own agreements can make things more complicated. For example, if the option agreement is in the lease, that could make it more difficult to evict the tenant from the property. While you can get around this by putting it in a separate document, that could involve legal costs and more paperwork.

Another danger is that rent-to-own deals have become rife with scam artists. Some offer to operate as middlemen between the owner and the tenant by guaranteeing a sale if the tenant decides not to buy. Other scams involve people who don’t own the property entering into false rent-to-own agreements. These scam artists then abscond with the fees that they collect.

Take Steps to Protect Yourself

If you do decide to buy or sell via rent-to-own, it’s critical that both the landlord and the tenant have their lawyers involved in preparing the agreement.

It should be written to be fair to all parties. For example, some rent-to-own agreements include clauses that are prejudiced against the tenant – such as saying that if the tenant is ever late on their rent, they lose their right to buy the house.

If you’re considering buying via rent-to-own, go to the local registry office in order to ensure that the person who is selling you the house is actually the owner and to check to see if there’s any liens against the title in the form of mortgages or other debt that could complicate a sale. Once you enter in the agreement, be sure to register the option agreement against the title.

Finally, it’s important to ensure that the portion of the rent that’s meant to be a deposit towards the purchase of the home be held in trust rather than by the landlord or a third-party until the tenant decides whether or not to buy the house. That way, if the tenant backs out of the deal, it’s easy for them to get that money back.

About Amanda Reaume

Amanda Reaume is a freelance writer who focuses on personal finance, credit, and real estate. Her work has appeared in the Vancouver Sun, The Windsor Star, and online at Forbes.com, Yahoo! Finance, ABC.com , Time.com, USAToday.com, FoxBusiness.com and many other sites.

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