Rent-to-Own Program

If you have a homeowner mindset and you are looking to build equity, use a smaller down payment, and build or rebuild your credit score, then a Rent-to-Own program is what you are looking for. This program was created with the purpose of helping out those with poor credit to eventually become proud and established homeowners.

How Does Rent-to-Own Work?

Essentially, a homeowner or investor will rent out a house that’s already in their name, similar to how a landlord would with an apartment. Potential homeowners or tenants can then rent the house, making regular payments to their landlord. Each rental home comes with a particular rental contract/agreement that the tenant must adhere to if they want to remain living there. Strictly speaking, there are two types of contracts that are offered, known as “option-to-purchase” and “lease-purchase”. If the renter chooses the option-to-purchase, they’ll sign an agreement that states that they have the option, but not the obligation to buy the house when their rental term is over. If they choose a lease-purchase, it means they have agreed to buy the house at the end of the term.

Note: Below, we’ve provided a basic example of how a typical rent-to-own agreement tends to work. However, every rent-to-own contract is different, meaning certain conditions apply in some cases where others will not. While some landlords will offer the option-to-purchase, some won’t, and so forth. So, if you are thinking of choosing a rent-to-own home, always read your contract over carefully and seek the advice of a professional if you have any concerns.

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The Option Consideration

With most rent-to-own agreements, the potential tenant will be required to pay what’s known as an “option consideration” or “option money”. This is a non-refundable, but an often negotiable deposit, which usually amounts to about 2-5% of the home’s final asking price. The option consideration is a separate contract that gives the tenant the right, but not the obligation to buy the house at the end of the rental period. If the tenant doesn’t wish to pay for the option consideration, the landlord might still let them rent the home, but they will not have the right to purchase it at the end of their lease. Depending on the terms of the agreement, the full sum or part of the option money may go toward the tenant’s eventual down payment on the home, but again, every contract is different.   

The Rent

After the agreement has been confirmed, the tenant will make regular payments, usually on a monthly basis, over several years (1-3 years is most common). The payments are divided into two parts, with one larger portion (about 75%) of each payment going toward the rental fee and the other (about 25%) going toward the down payment and eventual home equity. Once the lease is over, if the tenant still wishes to or is obligated to buy the house, they will have hopefully paid off enough of the down payment and raised their credit score sufficiently to qualify for a regular CMHC (Canadian Mortgage and Housing Corporation) insured mortgage. If the tenant’s agreement to purchase the home is optional and they don’t like the house or have any other reason not to buy it when their rental term ends, they can walk away from the deal.

The Final Asking Price

Once again, the terms of the rental contract will dictate what the new potential homeowner ends up paying for the home if and when they decide to buy it. Under some contracts, the final asking price for the home will be agreed upon and locked in before the tenant moves in. However, some rent-to-own contracts state that the asking price will only be determined at the end of the leasing term and will be based on the home’s appraised market value. Actually, the majority of tenants prefer to have the asking price locked in because the real estate market is always fluctuating.

Example Rent-to-Own Scenario

For the sake of argument, we’ll say that the rent-to-own agreement is for a 3-year contract. The renter agrees to pay $1,000 in rent per month, with an additional $500 per month that goes toward the down payment. Here’s how it will work:  

• The final asking price for the home is locked in at – $350,000
• The upfront deposit is – $8,750 (2.5%)
• The mortgage remaining at the end of the rental term is now – $341,250
• The monthly rent is – $1,000
• The monthly portion going toward the down payment is – $500
• $500 x 12 (months) = $6,000 (per year for down payment)
• $6,000 x 3 (years) = $18,000
• $341,250 –  $18,000 = $323,150 (remaining on mortgage after 3 years)    

So, by the end of their 3-year rental contract, the prospective homeowner should have invested $18,000 toward the down payment on the home. Something to keep in mind is that they’ve also paid $36,000 in rent over those 3 years, all of which will not be going toward the initial mortgage price. This means that they’ve invested $62,750 towards the home, but only $26,750 will actually go towards the final asking price.

Is a Rent-to-Own Program Right For You?

This program is only for those who are serious about owning a property and already have a homeowner mindset. The ideal client for the Rent-to-Own program is someone who:

• Wants to work toward becoming a homeowner as soon as possible
• Takes pride in ownership of the home
• Understands that real estate is a great way to build wealth
• Has had trouble receiving financing or has been declined by a mortgage lender before

What’s the minimum credit score for mortgage approval in Canada? Find out here.

The Advantages and Disadvantages

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.  

For The Seller or Real Estate Investor

Advantages

• Since a percentage of the renter’s monthly payments are going into the seller’s pockets, they could stand to receive a very decent profit on their investment, especially once the house is finally sold.
• Because a house is more desirable than the average apartment, they’re also in a position to charge a higher amount for rental fees.
• If the tenant chooses the option-to-purchase consideration, the deposit fee can be collected upfront. If the tenant doesn’t purchase the home at the end of their rental term, they’ll forfeit their deposit to the landlord.   
• While the property still belongs to the seller, they are usually not responsible for any repairs or renovations that need to be done on the house. 
• If the contact is a lease-purchase or the tenant does want to buy the home, the seller not only retains the money they’ve earned from rental fees, but their house is will officially be sold.

Disadvantages

• Rather than putting their house up for sale right away, sellers must now go through the same tenant-screening process a typical landlord would (performing background and credit checks, etc.).
• 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. The seller then needs to find another renter and arrange a whole new screening process.  
• Since the home is still in the seller’s name, they’ll have to continue making mortgage payments to their lender until the home is officially sold. The rental fees might only just cover those payments.

For the Tenant/Potential Homeowner

Advantages

• If the contract is an option-to-purchase, the tenant has the right to terminate their rental agreement at the end of their rental term. This means they can have a “test-run” with the house. If they don’t like the neighbourhood, the contract terms or the house itself, they don’t have to buy it.
• As the monthly payments are made the tenant/buyer’s credit rating will continue to increase until it is time to buy the home.
• Acquire equity in the property through building improvements
• The non-rent portion of the payments that the tenant makes goes toward the down payment on the home. For those who cannot initially afford said down payment, they can both add to it gradually and have time to build up their finances.
• If the asking price is locked in, the tenant will then pay that price for the home (not including rent payments) at the end of their contract, even if the real estate market fluctuates and the house rises in value.

Disadvantages

• If the tenant’s finances and credit score have not improved by the time their rental agreement expires, they may not receive the necessary financing to purchase the house.
• If the contract is an option-to-purchase, and the tenant has paid for the option consideration but does not purchase the house, their deposit will be lost.
• Unlike an apartment, in some rent-to-own cases, tenants are responsible for all required repairs and maintenance. They might also have to pay for homeowner’s association fees, property taxes, and insurance.
• The landlord still technically has the property in their name and must continue to make the mortgage payments. So, if they start defaulting, the home might be foreclosed.
• Some landlords are also more strict than others. So, if you default on your payments for too long (sometimes 90 days), they might threaten to evict you or take legal actions against you.  
• Because the asking price of the house is coupled with the rental fees and all other homeowner related costs, the renter might end up paying much more than the house is actually worth and might not receive their investment back if they decide to resell it in the future.

Bottom Line

The Rent-to-Own program gives you the ability to begin investing in owning a home today and avoiding the cash pit of rent. This program will help you to be more financially responsible, stay on track and go through the necessary steps to build the equity and credit rating required to qualify for a mortgage. The Rent-to-Own program will put you well on your way to becoming a homeowner in no time, and you also receive the added benefits of a stronger credit rating and real equity in your property.

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.