Purchasing Residential Properties under the Rent-to-Own Process: A concept gaining momentum in the current ominous real estate market
For many Canadians, owning a home is a dream. However, over the past few years, this has proven to be difficult to attain due to the rocky and inconsistent real estate market sphere.
The interest rates are at the highest that they have been in over a few decades along with the climb in housing prices. As a result, a myriad number of homebuyers are being priced right out of the market and are looking for alternative options to reach their dream of purchasing a home. Purchasing condos, pooling resources, dividing the cost of a home between numerous parties by entering into a co-ownership agreement, or relocating to a different province, are some of the options that homebuyers have been recently exploring. I recently wrote an article on the co-ownership option.
The rent-to-own concept has traditionally been geared toward individuals who are unable to qualify for a traditional mortgage due to poor credit. However, as a result of the recent real estate market, rent-to-own is becoming a realistic option for those homebuyers who have viable credit but either do not have enough money saved up for a downpayment or are prevented from jumping through the current stringent threshold in order to qualify for a mortgage. Let us take a closer look.
The rent-to-own concept involves a potential purchaser entering into an agreement with either a landlord or a rent-to-own company. The landlord or a rent-to-own company would rent a property to a potential purchaser however, the rent payments are allocated in a different manner. Specifically, a portion would be allocated towards the rent, and a portion called the “rent credit” would be set aside and allocated towards the purchase of the property (i.e., downpayment) at a later date.
The percentage allocated towards rent and the rent credit is negotiable and should be clearly stipulated in the rent-to-own agreement before it is executed. There are two types of agreements associated with the rent-to-own regime. The first is the option-to-purchase. If this option is chosen, the potential purchaser may purchase the property but is not obligated to at the end of the lease term. On the other side of the spectrum is the lease-purchase. If this option is chosen, the potential purchaser must purchase the property at the end of the lease term. The lease-option agreements are recommended as they are more consumer-friendly and the potential purchaser does not risk getting sued if they are unwilling or unable to purchase the property once the lease term expires. With this in mind, you as a potential purchaser must take extra precautions to protect your interest, enter into the right agreement that makes the most sense for your particular circumstances, and review the terms of the agreement with your lawyer before it becomes legally binding.
Please be mindful that some rent-to-own agreements require that the purchase price be determined at the end of the lease term and be based on the current market value, while others will require that the purchase price be agreed to before the agreement is signed. Again, the potential purchaser will have to decide what option better suits their circumstances. Some prefer to have the purchase price locked in from the onset while others prefer to drift with the fluctuating real estate market and agree to the purchase price at the end of the lease term. In any event, once the agreement is signed and it becomes binding on both parties, the potential purchaser will be required to commence regular monthly payments over the term agreed upon, which most commonly is between one (1) to three (3) years.
Furthermore, the potential purchaser will also be obligated to pay a one-time nonrefundable but negotiable upfront fee called the option fee/deposit/consideration. This fee gives the potential purchaser the option to purchase a property that they are renting at the end of the lease term. The fee ranges between 1% to 5% of the purchase price. The said fee is later deducted from the agreed-upon purchase price.
Example of Rent-to-Own
- Agreed Property Purchase Price: $450,000.00.
- Rent-to-Own Agreement Term: 3 years (36 months).
- Monthly Rent: $1,700.00.
- Monthly portion towards downpayment: $500.00.
- Option Deposit: $9,000.00 (2.0% of the asking price).
- Remaining at the end of the lease term: $441,000.00 ($450,000.00-$9,000.00).
- $500.00 x 12 months =$6,000.00 (per year saved towards the downpayment).
- $6,000.00 x 3-year term= $18,000.00 (saved over 3-year term towards the downpayment).
- $441,000.00 -$18,000.00=$423,000.00 (mortgage remaining after 3 years).
In the above case scenario, the potential purchaser would save $18,000.00 over the three (3) year lease term to be allocated towards the purchase price. However, please be mindful that the potential purchase has also paid $43,200.00($1,200.00 x 36 months) towards rent, which none would be allocated towards the purchase price. So, the potential purchase invested a total of $70,200.00 ($9,000.00 + $18,000.00 + 43,200.00) toward the property but only $27,000.00 ($9,000.00 + $18,000.00) would be allocated towards the purchase price at the end of the three (3) year term.
Advantages and Disadvantages for a Potential Purchaser
- The purchase price is usually locked in before the agreement is executed. The potential homeowner will pay the same purchase price at the end of the lease term regardless of the fluctuations in the real estate market.
- Potential purchaser does not need to pay the downpayment upfront.
- The potential purchaser can build a stronger credit over the lease term.
- The potential purchaser can test out being a homeowner and determine if they want the commitment long-term.
- The potential purchaser can move into the property right away.
- If the prices of homes decrease due to the fluctuating real estate market but the purchase price is locked in, the potential owner could be paying more for the home than what it is worth at a given time. Also, the purchase price is coupled with a larger portion going towards rent and a smaller portion going towards the rent credit as we have seen in the scenario above (i.e., the total of $70,200.00 was invested but only $27,000.00 would be allocated towards the purchase price after the lease term expires).
- The landlord can still evict the potential purchaser if they default in payment and/or take legal action.
- The potential owner may be responsible for all the repair and maintenance and may be further responsible for paying property taxes and insurance.
- The potential owner may be restricted from renovating the property during the lease term.
- If the potential purchaser has chosen the lease-purchase option and if they do not end up purchasing the property for some reason (i.e., cannot qualify for a mortgage), the option fee/deposit/consideration that was paid will be forfeited to the landlord or the rent-to-own company.
- The potential purchaser will still need to qualify for and obtain the necessary financing to purchase the property after the lease term expires. If this is an obstacle, the potential purchaser has invested money already into the property and will lose all of it if they are unable to obtain financing.
The rent-to-own concept is an appealing one and can work well for many individuals however, before you decide to proceed with this regime, you must ensure that you perform your due diligence as you would with any contractual transaction. The best course of action is to retain a lawyer to review the rent-to-own agreement with you so that you understand your legal obligations and to negotiate certain terms of the agreement to help you avoid a deal that may be unfavourable to you.
I cannot stress enough how imperative is to understand the difference between option-to-purchase v. lease-purchase agreements. As mentioned above, the option-to-purchase gives you the right, but not the obligation to purchase the property after the term of the lease expires. You can walk away without the obligation to continue paying the rent or to buy the property. On the other hand, the lease-purchase places an obligation on you to purchase the property at the end of the lease term, which could pose a problem if you are unable to afford it or do not wish to own it.
- The rent-to-own agreement is a contract that you enter into with the intention to rent a property for a specific amount of time with the option to purchase it once the lease term expires.
- These agreements are very involved and include the lease agreement portion along with the option to purchase portion.
- The option-to-purchase provides you with the right to purchase the property when the lease term expires.
- The lease-purchase option requires you to purchase the property when the lease term expires,
- You will lose the option deposit and any rent credit if you do not purchase at the end of the lease term. This is why it is important to retain a lawyer to negotiate the terms of the agreement on your behalf.
- You may be responsible for paying for repair, maintenance, and property taxes during the term of the lease. This is why it is important to retain a lawyer to negotiate the terms of the agreement on your behalf.
I hope that this article has provided you with some helpful information. If you have any questions, please do not hesitate to contact me at firstname.lastname@example.org