Renting can feel like a waste as every payment you make doesn’t help you build credit or pay towards owning the place you rent. Unfortunately, renting is usually the only option for many people as it’s more affordable than buying a house. That’s where the rent-to-own program comes into play, it was created with the purpose of helping out those with poor credit to eventually become proud and established homeowners.
What Is Rent-To-Own?
The rent-to-own program involves entering an agreement between you and your landlord or rent-to-own company. Essentially, the landlord or rent-to-own company will rent out a house to you similar to how a landlord would with an apartment. The difference lies in the way the rent payments are used. The rent payments will not only pay your rent but a portion would be saved to go toward the purchase of the house you’re renting. This is referred to as “rent credit”.
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.
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 – 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.
- Lease-Purchase – If they choose a lease-purchase, it means they have agreed to buy the house at the end of the term. If you do not purchase the home regardless of the reason why (failure to secure a mortgage or simply a change of heart), can lead to a penalty.
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How Does Rent-To-Own Work?
Each rent-to-own home comes with a particular rental contract/agreement that the tenant must adhere to if they want to remain living there and have the opportunity to purchase the home. But generally, you can expect the following when you enter a rent-to-own agreement.
- Make Payments – Rent-to-own tenants will make regular payments to their landlord.
- Build Rent Credit – As you make payments, you’ll build your rent credit, which can be used as a down payment or help you qualify for a mortgage.
- Own Home – At the end of the lease (or at any point during the lease) you can apply for a mortgage. If you qualify, you can purchase the home and use the rent credits towards to purchase price.
How Does The Rent Work?
After the agreement has been confirmed, the tenant will make regular payments, usually on a monthly basis, over several years (1-3 years is the 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.
What Is The Option Deposit?
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 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.
Purchasing The Home
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.
Real Life Example Of Rent-To-Own
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 option deposit is: $8,750 (2.5%)
- The mortgage remaining at the end of the rental term is now: $341,250
- The monthly rent is: $1,500
- 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 toward the home, but only $26,750 will actually go toward the final asking price.
Advantages And Disadvantages Of Rent-To-Own
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.
Advantages For the Tenant Or Potential Homeowner
- Test Out Home With No Penalty – 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.
- Helps Build Credit – As the monthly payments are made, you’ll 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 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.
- Lock-In Asking Price – 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 For the Tenant Or Potential Homeowner
- Need To Qualify For A Mortgage To Buy – 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.
- Can Lose Deposit – 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.
- Responsible For Maintenance – 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 homeowners’ association fees, property taxes, and insurance
- 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, 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.
- Landlord Can Evict You – 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.
Are There Advantages For The Seller or Real Estate Investor
Just as there are advantages and disadvantages for the tenant, there are advantages and disadvantages for the seller.
Advantages For The Seller or Real Estate Investor
- Profitable – 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.
- 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.
- Can Keep The Deposit – 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.
- Don’t Have To Maintain Home – 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.
- House Is Sold – If the contract 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 will officially be sold.
Disadvantages For The Seller or Real Estate Investor
- Tenant Screening – 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.).
- 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. The seller then needs to find another renter and arrange a whole new screening process.
- Still Responsible For Mortgage Payments – 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.
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
- 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
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?
Who is responsible for the rent-to-own repairs and maintenance?
How long is a rent-to-own home program?
The Rent-to-Own program gives you the ability to begin investing in owning a home today. 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.