Are you getting fed up of renting apartments? What if you rented but simultaneously paid toward owning that house? That is the concept behind a rent-to-own home plan, aka lease-to-own homes.
With the high rents and tight housing market in Canada, renting-to-own your home is more appealing than ever. It combines the equity building component with the liquidity of renting.
It is a good compromise if you don’t have the finances necessities to qualify for a mortgage, such as a good credit score or enough money for a down payment, but still want to be a homeowner.
You may be paying off debts or have gone through a recent consumer proposal or bankruptcy, both of which can also make it hard for you to get the approval you need. So, if you still want a house someday, you might have to consider other alternatives, including personal loans or credit building programs. Whatever avenue you choose, homeownership is not an easy task.
However, what exactly is a rent-to-own home? And, for that matter, what about this homeownership option appeals to Canadian renters?
Like with any significant financial commitment involving real estate, rent-to-own deals come with upsides and downsides. It’s best to know a bit about them before you determine if it’s the right path for you.
So, if you’re thinking about renting your next home so that you can possibly own it one day, or if you’re just curious about how a rent-to-own deal works, keep reading, we have the answers you need.
Read more about of leasing a car or entering into a lease-to-own agreement
How Do Rent-To-Own Home Programs Work?
When it comes to living in North America, rent-to-own homes are more often seen in the United States. However, they do show up all over Canada, especially in provinces like British Columbia, Alberta, and Ontario, where housing prices can be astronomically high in and around urban areas.
In fact, one of the main reasons why rent-to-own homes are so appealing is because they’re presented as a more affordable option for homebuyers who either don’t qualify for a typical mortgage or don’t have enough money to afford a reasonable down payment. They’re also alluring to people who already own a home and are trying to sell it, or for real estate investors, both of whom are interested in the possibility of earning a profit once the home is sold.
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.
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. A contract is worth spending time and money on to make sure that you are protected from surprises later on. You need to understand what the terms are and any payment penalty associated with breaking a contract.
Rent to Own Home Agreement: 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% to 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 towards the tenant’s eventual down payment on the home. However every contract is different.
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 towards 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.
Rent-To-Own Home Contract: 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.
A Basic Example
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 towards the down payment. Here’s how it will work:
- The home purchase price is locked in at $350,000
- The upfront deposit is $8,750 (2.5% of purchase price)
- The mortgage remaining at the end of the rental term is now $341,250
- The monthly rent is $1,000
- The monthly portion going towards 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 has invested $18,000 towards the down payment on the home.
The problem is that they’ve also paid $36,000 in rent over those 3 years. None of that money goes toward the purchase. This means that they’ve invested $62,750 towards the home, but only $26,750 will actually go towards the final asking price.
Rent-To-Own Home Arrangements: The Advantages and Disadvantages
That leads us to our next section. As we mentioned earlier, all rent-to-own agreements come with advantages and disadvantages for both the seller and the renter, so it’s very important to know what they are before you sign any contracts.
For The Seller Or Real Estate Investor
- A percentage of the monthly rent might go to the seller and not the down payment or mortgage. The stands to profit on their investment. Even better, they might avoid any commissions to pay to realtors when the house changes hands.
- Because it’s a house, landlords are in a position to charge a far higher amount for rental fees.
- If the tenant chooses the option-to-purchase consideration, the deposit fee can be collected up front. If the tenant forfeits their deposit to the landlord if they don’t buy the house.
- The property belongs to the seller but the tenant is responsible for repairs or maintenance on the house. Also, if the tenant makes any renovations, it comes out of their pocket, not the seller’s.
- In the end, the seller collects rent and has the peace of mind that their house is easily sold.
Disadvantages For The Seller
- Sellers still go through the same tenant-screening process a typical landlord would (performing background and credit checks, etc.).
- An option-to-purchase does not obligate the renter to purchase the house at the end of the rental term. They can 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 are responsible to continue making mortgage or loan payments to their lender until the home is officially sold. The rental fees might only just cover those payments.
For the Tenant/Potential Homeowner
- 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 neighborhood, the contract terms or the house itself, they don’t have to buy it.
- If the tenant has poor credit, a few years of renting can give them sufficient time to raise their credit score through other means, such as timely credit card payments, etc. A higher credit score translates to an easier time qualifying for a conventional mortgage.
- The non-rent portion of the payments that the tenant makes goes towards 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.
- When you lock-in the asking price, the tenant pays that price for the home (not including rent payments) at the end of their contract, even if the house value rises.
Disadvantages To The Renter/Buyer
- If the tenant’s finances and credit score don’t improve by the time their rental agreement expires, they may not receive the necessary financing to purchase the house.
- The tenant loses their deposit in an option-to-purchase situation but does not purchase the house.
- 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 default, the bank can foreclose on the home you plan to buy.
- 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.
- The house’s selling price considers the rent and all other homeowner related costs. The renter can pay much more than the house is actually worth. If they ever resell the house, it might be for less. However, that can happen in any reselling situation.
Know Who You’re Dealing With And Be Wary of Scams
As it is with any real estate transaction, it’s extremely important that if you’re to know exactly who you’re dealing with. Sometimes it requires research and not trust.
Problems can arise in some rent-to-own cases when a third-party gets involved. A third-party jumps get involved and claims they can better manage the money including the deposit or down payments. Some guarantee the landlord another buyer if the current tenant doesn’t purchase the home. All of these services and guarantees come with a service fee.
Unfortunately, some these third-party associations are scam artists, who will take their fee, then back out of the deal. That was the case with the Golden Oaks Enterprises real estate scandal of 2013 in Ottawa.
Therefore it’s always a good idea to consult a professional before deciding to rent a home or put your home up for rent. In fact, some real estate lawyers specialize in these types of contracts.
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Rent-To-Own Recap: Consult A Professional
It’s always important to speak to a professional advisor before making any big financial decisions. Rent-to-own homes, like any form of real estate transaction, come with upsides and downsides.
Any potential renter or seller of a rent-to-own dwelling has to understand all of these factors before making a decision. And, in most cases, a bit of online research is not enough.
To be safe, consult both a financial advisor and a real estate professional. These include realtors, notareis or a real estate lawyers. Remember, becoming a homeowner is one of the most important and expensive decisions in life. Take the time and do the research before you make any binding decision.
Are Rent-To-Own Homes Legal in Canada?
Yes, it is legal to rent-to-own a home in Canada. Do not confuse the term rent-to-own plans with rent-to-own-home plans. Rent-to-own plans without mention of a home often refers to lease-to-own, rent-to-buy, option leases and consumer leases. They typically apply to electronics, appliances, furniture, and cars.
What Happens To My Deposit If I Don’t Go Through WIth A Rent-To-Own Home Plan?
Your seller might require an up-front-deposit for your rent-to-own option consideration. If you back out of the deal, you forfeit the deposit. That means that you do not get it back.