For many people, owning your own home is the dream. However, over the past few years, watching housing prices climb has been more of a nightmare. As a result, many first-time homebuyers have found themselves priced right out of the market or looking for other options to reach their dream. Purchasing smaller homes or condos, borrowing money from relatives, or even moving across the country in pursuit of home ownership are options. There is one other less common option to consider: rent-to-own homes. In this article, we dive into what they are, how to do it and present pros and cons to help you decide whether or not it’s the right option for you.
What is a rent-to-own home?
Rent-to-own agreements is a home buyer method that allows potential buyers to save for a down payment while renting the home they eventually plan to buy. It is an agreement that you will enter into with either your landlord or a rent-to-own company. A portion of your monthly rent, known as a “rent credit”, will go towards a down payment of the home. Over time, the down payment grows and, eventually, the tenant is able to purchase the home outright off their landlord.
You will have the right to purchase the property, either during your lease or once your lease expires. However, you are not forced to purchase. This can range from one year to five years. Should you choose not to purchase the home, you will lose the rent credit that you have built up. A rent-to-own agreement binds your landlord to selling the home to you. Your landlord cannot sell the home to anyone else during the option period of your agreement.
How these types of homes work in Ontario
In order to rent-to-own in Ontario, there are two agreements both the tenant and landlord must enter into:
- A lease agreement
- An option to purchase agreement, signed by the owner and the tenant
Similar to a basic rental agreement, you will pay monthly payments at a set price for a pre-determined time period. The only difference with rent-to-own homes is the portion of money being set aside to eventually buy the rental at a later date.
The agreements cover things, such as:
- The lease term (i.e. how long you will lease the home)
- The rental price
- The percentage of the rental costs set aside for a down payment
- Possession date of the property
- The contract expiry date
- The home purchase price
Essentially, by paying a fee, you can live in the home and save up the required down payment rather than paying upfront. A set period of time, such as three years, is agreed upon at the outset. This fee, also known as the option deposit, ranges from 2-2.5% of the purchase price, and is later deducted from the agreed purchase price.
In this type of agreement, you will still need some cash upfront to get started. Additionally, you’ll need to be putting aside additional funds for the 5% down payment due in three years. Like all important contracts, make sure a lawyer reviews all documents to help you understand the agreement and expectations clearly before signing.
- Agreed purchase price: $500,000
- Option to purchase deposit: $500,000 x 2.5% = $12,500 (due at tenant move-in date)
- Amount owing after three years: $500,000 – $12,500 = $487,500
- 5% down payment required: $487,500 x 5% = $24,375
- Monthly rent: $2,000
- Rent credit / extra funds for future down payment: $800/month
- Down payment saved after three years: $800 x 36 months = $28,800
Amount leftover after putting down 5%: $28,800 – $24,375 = $4,425
In this example, the tenant will save $28,800 for the down payment over three years, while they are renting the property. After putting 5% down ($24,375), they can save the remaining money ($4,425) or put it towards closing costs.
PLEASE NOTE: These numbers are only used to illustrate how a potential rent-to-own scenario could work.
The pros of lease-to-own homes
Rent-to-own is designed to make buying a home easier for Canadians to enter the real estate market. If you are considering a rent-to-own home, here are some of the advantages:
- Build your savings: The main advantage is that it allows you to address specific financial issues that would otherwise hold you back from fulfilling your dream of home ownership. You can build up your savings account directly and through option deposits that can be applied to the home purchase.
- Build up a low credit score: Allows you to move into your future home and work towards building your down payment. This will also help you to increase your credit score, which can positively impact a mortgage.
- Test drive before you buy: While you rent-to-own, you take more pride in where you are living since it will one day be yours. Rent-to-own allows you to ‘kick the tires’ before committing.
- Move in right away: Another benefit for tenants or buyers is that they can move into the home right away without waiting until the closing dates. This makes it easier for people who need a place to live right away or are moving for a job.
The cons of lease-to-own homes
Here are some of the disadvantages or potential risks of a rent-to-own home:
- Buyer’s remorse: If you enter into a lease-to-own agreement and choose not to purchase the home, you will likely lose all the money accrued toward a down payment.
- Missed payments: If you miss a payment, it may nullify the agreement. It would also most likely result in the loss of the down payment savings.
- Restrictions: During the leasing period, you may be restricted from updating or renovating the house to suit your needs.
- Property value: If the property value decreases during the lease period, you will likely still need to pay the original price. Be sure to go through the contract with a lawyer and understand the ins and outs.
- Due diligence: Be sure that you negotiate a home inspection before entering into a lease-to-own agreement. Many times, issues with the property are uncovered after the purchase is made final.
- Mortgage qualification: You must be able to qualify for a mortgage at the end of the rental period. That means, if any issues persist, you may not be able to purchase the home.
- Watch out for scams: Some landlords or investment companies find ways to make their money off these kinds of properties and willing tenants. In some cases, these landlords and companies make you responsible for paying off their debt with high rent prices.
- Add-on costs: Many owners may choose to include a clause in the contract that states, if home values rise significantly, you may have to pay more in the end.
- Not that common: While there are opportunities for rent-to-own agreements to occur, they’re not very common. As we have seen escalation of home prices over the past few years, many landlords may be reluctant to enter into such an agreement. However, some experts contend that the pricing bubble may be deflating by year’s end, so this may change landlords’ willingness to consider rent-to-own.
For a list of rent-to-own companies, please click here.
Do I need insurance for a rent-to-own home?
If you’re renting to own, you should obtain renters insurance to protect your belongings. Additionally, it will provide you with legal protection if someone files a lawsuit against you, and provide living expenses if something happens to the dwelling and it becomes uninhabitable. Once you own the property, you will need home insurance since you now own the house.
To learn more about rental properties and tenant insurance, please click here.
Final thoughts on rent-to-own homes
Despite the volatile housing market, if the dream of home ownership is still alive for you, then rent-to-own homes might be worth considering. The struggle to obtain a mortgage may be lessened by the opportunity to build your credit with rent-to-own. But remember, it’s imperative to enter into the agreement with your potential landlord fully informed. Run all documents past your own legal counsel – they will be looking after your best interests. It’s important that you understand the stipulations and requirements of this type of contract.
Research the person or company offering the rent-to-own agreement to fully understand who you’re doing business with. Finally, contact one of our isure brokers and inform them of your plans. We may be able to offer advice and guidance as to what the best type of coverage is for your needs. And when the lease is over, let’s discuss how we can help your dream be properly protected for years to come.