Renting is often the only option for many Canadians, as it can be more affordable than buying a house without the need to qualify for a mortgage. But renting simply means paying someone else’s mortgage. Plus, your rent payments don’t do anything to help you build credit.
A rent-to-own program may be a potential pathway to homeownership for you that allows you to rent a property with the option to buy the home at a later date. Let’s go into more detail about how rent-to-own programs work, as well as their perks and drawbacks.
Key Points
- A rent-to-own program can help you gradually become a homeowner if you’re unable to qualify for a mortgage today.
- Rent-to-own programs allow you to rent a home with the option to eventually buy it at an agreed-upon price.
- Part of each rent payment you make will go toward the down payment of the home if you eventually decide to purchase it.
What Is Rent-To-Own In Canada?
A rent-to-own program is an arrangement that allows tenants to rent a property with the option to buy it at a later date. This type of agreement is designed for those who eventually want to become homeowners but may not be financially capable of qualifying for a traditional mortgage.
Types Of Rent-To-Own Programs
Strictly speaking, there are two types of contracts that are offered, known as “option-to-purchase” and “lease-purchase”.
Option-To-Purchase
An option-to-purchase agreement allows the tenant in the agreement to exercise their right to purchase the property within a certain time period at an agreed-upon price. The tenant is not obligated to purchase the home and may choose to walk away from the purchase.
Lease-Purchase
A lease-purchase arrangement means the tenant agrees to buy the home at the end of the contract. Unlike in the previous arrangement, the tenant is obligated to go through with the purchase of the property at the end of the term. Failure to do so may lead to penalty fees.
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How Does Rent-To-Own Work?
In a rent-to-own program, you and your landlord or rent-to-own company will enter into an agreement, similar to a traditional lease. The agreement will be structured according to the specific program you choose; option-to-purchase or lease-purchase.
A rent-to-own agreement is made up of the following components:
Option Deposit
With most rent-to-own agreements, you may be required to pay an option deposit upfront. This is a non-refundable deposit, which usually amounts to about 2% to 5% of the home’s final asking price.
Depending on the terms of the agreement, the full sum or part of the option deposit may go towards your eventual down payment on the home.
Rent Payments
Once the agreement has been confirmed, you’ll make regular payments for the duration of the contract term. Part of these rent payments — also referred to as ‘rent premiums’ or ‘rent credits’ — goes towards the down payment or purchase price. This is one of the biggest benefits of a rent-to-own program over a traditional lease agreement.
Contract Term
Rent-to-own programs typically last between 1 and 5 years, during which (or at the end) you can choose to use your rent credit to help you purchase the property. If you do not purchase the property by the end of the lease, you’ll lose all the rent credit. And if you choose the lease-purchase option and don’t buy the house, you could face penalties.
Ideally, you’ll have paid off enough of the down payment and raised your credit score sufficiently to qualify for a traditional insured mortgage.
Agreed-Upon Purchase Price
The future purchase price of the home is typically agreed upon at the beginning of the contract. If you decide to buy the home when the lease ends, the purchase price specified in your contract is what you would pay for the home.
However, some rent-to-own contracts state that the asking price will only be determined at the end of the lease term and will be based on the home’s appraised market value.
Real Life Example Of Rent-To-Own
To illustrate how a rent-to-own program works, let’s use the following example.
- Contract length: 3 years
- Locked-in purchase price: $350,000
- Option deposit: $8,750 (2.5%)
- Monthly rent: $1,500 ($1,000 towards rent, $500 towards the down payment)
- Amount owing at the end of the term: $341,250 ($350,000 – $8,750)
- Down payment contributed over 3 years: $18,000 ($500 x 36 months)
- Mortgage amount at the end of the lease agreement: $323,150 ($341,250 – $18,000)
So, by the end of the 3-year rental contract, you should have invested $18,000 towards the down payment on the home. This meets the minimum 5% deposit requirement, which would be $17,500 ($350,000 x 5%).
Something to keep in mind is that you’ve also paid $36,000 in rent over those 3 years (not including the $500/month for the down payment), all of which will not be going toward the initial mortgage price.
Pros And Cons Of Rent-To-Own For Tenants
If you believe you’re a good candidate for the rent-to-own program, you should be aware of the advantages and disadvantages for both the seller and the renter. It’s very important to know what they are before you sign any contracts.
Pros
There are plenty of perks that come with a rent-to-own program:
- Become A Homeowner — If you’ve had trouble overcoming the typical barriers to get into the housing market, a rent-to-own program can help you become a homeowner in a different way that suits your finances.
- Test Out The Home – If the contract is an option-to-purchase, you have the right to terminate your rental agreement at the end of the term. This means you can have a “test-run” with the house to see if it’s a home and neighbourhood that suits you.
- Helps Build Credit – As the monthly payments are made, you can build a good payment history, which may positively affect your credit.
- Helps Save For A Down Payment – The non-rent portion of the payments that you make goes toward the down payment on the home. If you can’t initially afford a down payment, you can add to it gradually.
- Lock-In Asking Price – If the asking price is locked in, you’ll benefit if property values increase during the lease term.
Cons
Along with the benefits of a rent-to-own program come a few notable downsides to consider:
- You Still Need To Qualify For A Mortgage – While you won’t have to get approved for a mortgage to enter into a rent-to-own agreement, you’ll still need to qualify if you plan to buy the home at the end of the lease term.
- You Can Lose Your Deposit – If you’re on an option-to-purchase contract and choose not to purchase the house at the end of the lease, you’ll lose your deposit.
- You May Be Responsible For Maintenance – In some rent-to-own cases, you may be required to handle maintenance and repairs.
- You May Pay More Than The House Is Worth – Because the asking price of the house is coupled with the rental fees and all other homeowner-related costs, you could end up paying much more than the house is actually worth. As such, you could also fail to recoup your investment if you decide to resell it in the future.
Pros And Cons Of Rent-To-Own For Sellers And Real Estate Investors
Just as there are advantages and disadvantages for the tenant, there are advantages and disadvantages for the seller.
Pros
Investing in a rent-to-own property also comes with certain advantages, such as the following:
- Cash Flow — Rent-to-own agreements often allow for owners to charge higher rent compared to standard rentals. This provides a steady stream of cash.
- You Can Charge Higher Rent – Because a house is more desirable than the average apartment, they’re also in a position to charge a higher amount for rental fees.
- You Can Keep The Deposit – If the tenant chooses the option-to-purchase consideration and doesn’t buy the home at the end of the lease, you can keep the upfront deposit.
- You Don’t Have To Maintain The Home – While the property still belongs to you, you’re usually not responsible for any repairs or renovations that need to be done on the house. Just make sure the contract stipulates these details.
Cons
Make sure to consider all potential drawbacks as the owner of a rent-to-own property, such as the following:
- Risk Of Selling At A Lower Price Than The Home Is Worth — If the home is worth more than the locked-in price by the end of the term, you could lose out on additional profits.
- The Tenant Can Walk Away – If the contract is an option-to-purchase, the renter is not obligated to purchase the house at the end of the rental term. They’ll be allowed to terminate the deal at any time or when their rental agreement expires. You’ll then need to find another renter and arrange a whole new screening process.
- You’re Responsible For Mortgage Payments – Since the home is still in your name, you’ll have to continue making mortgage payments to your lender until the home is paid off.
Is A Rent-To-Own Program Right For You?
A rent-to-own program may be a great option for you if you …
- Can’t afford a home right now
- Are unable to get approved for a mortgage
- Want to work towards becoming a homeowner
- Want to build equity in a home
- Need time to build your credit score
Bottom Line
A rent-to-own program can be a great way to help you eventually become a homeowner if you’re unable to meet the standard requirements for a mortgage. With every rent payment you make, a portion will go towards the down payment, which gives you a few years to save up and contribute. Plus, on-time payments can help you build good credit, which will be needed when you eventually have to apply for a mortgage to buy the home.
Rent-To-Own In Canada FAQs
Do I need rent-to-own insurance?
Who pays for maintenance for a rent-to-own home?
Should I lock in the asking price?
What happens if I choose not to buy the rent-to-own home?
How long is a rent-to-own home program?
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