A landlord rents the home or condominium under a basic home lease. For an extra payment, the tenant receives an option to buy the home at a later date, for a set price. Let’s say the home is worth $250,000. The parties agree the tenant will have the right, but not the obligation, to buy the house in three years for $280,000.
The fee for this right, or option, is usually 2 or 2 ½ per cent of the final price. In this example, 2 percent of $280,000 would be $5,600. Then, each month, the tenant pays an extra fee, say $200, that also is applied to this option price. At the end of the three-year lease term, the tenant has put up close to 5 per cent towards the purchase price option. In this example, it would be close to $13,000.
If the tenant exercises their right to buy, they can use the $13,000 as the down payment and apply for a mortgage to finance the rest of the purchase.
Here are some of the advantages for the tenant:
You may not have the down payment now, but you will have it at the end of your lease, as a result of the additional payments;
If your credit is not good, you can improve it by making timely payments of rent;
You can try out the neighbourhood and if you change your mind later, you can just cancel the option;
If the market price of this home is more than $280,000 at the end of your lease, you still get to buy it for the same $280,000.
If the market collapses and the home is worth less than $280,000, you do not have to go through with your purchase.
Here are some disadvantages:
There is no guarantee that a bank will give you your financing when you exercise your option. You still have to improve your credit score or find someone to co-sign your application;
If you don’t go ahead with your purchase, you usually have to forfeit the option payment.
Here are some advantages for the landlord:
Tenants on rent-to-own typically take better care of the property, thinking that they may own it one day;
Your profit is fixed at the time of the option.
In all cases, it is important that the parties have legal advice. Some agreements state that if your rent is late once, the tenant forfeits the right to buy the home. This needs to be changed so that as long as the tenant cures any default in a timely manner, they do not lose the right to buy.
The tenant should also have the title checked to make sure that the correct owner of the home is giving the option.
Landlords need to make sure that the option payment is covered in a separate agreement, and is not included in the lease. If it is included in the lease and then the tenant defaults, if can be harder to evict the tenant from the property. Landlords also need to conduct a thorough credit and background check, to make sure that the tenant looks like they will have the means to make all of the required payments.
Rent to own can work for landlords and tenants if you are properly prepared in advance.
Mark Weisleder is a Toronto real estate lawyer and REIN Expert.
It’s a service offered to some that can’t qualify yet for a mortgage. Like any business there are sharks or shady players. No one is forced to enter into a rent to own situation. It’s also not 50% interest usually.
Don’t confuse a shady deal you may have witnessed somewhere with the principle of allowing folks to occupy a home with a payment plan and the option to acquire it later.
Ever heard of Sharia compliant lending? That is essentially a rent to own concept as bank holds title, thus no mortgage (forbidden under strict Islam / Sharia law ), with a payment plan of 25-30 year then ownership !!
Given that a rent to own client usually has weaker credit ie is higher risk it is ok to charge more than a usual 3-4% interest rate.
Thomas Beyer, Asset Manager, Investor, Community Improver, Author, Father, Mentor www.prestprop.com
RTOs are fraught with risk and really takes a team of experts to be able to pull off. I only really recommend them when you have a dog that you need to get out of and you can't sell at retail for a deal that's palatable.
The trick with them is to stay away from this concept of setting the future value based on some formula of market growth. You can only sell for appraised value in the future, because that's all the buyer will be able to qualify for. If you try and sell for more and if the difference between the appraised price and the option price is greater than the tenant/buyer's deposit then they have more incentive to walk away than close, and when this happens they try and wiggle out of the deal and tenancy laws come into the picture and it gets messy.
However if you have a non-conventional rental property (say a house) that doesn't cash flow then RTOs can work. You set the rent plus a premium. The premium counts as a schedule of additional non refundable deposits made each month towards the purchase price. purchase price is set based on an appraisal (or combination of appraisals) at the end of the lease.
If it works out the seller gets a premium rent to cover off the negative cash flow, they get to stay away from minor R&M issues and they can line the closing date up with the expiry of their mortgage to avoid payout penalties, and usually there is a savings on sales commissions as well. The tenant / buyer gets to live in the property as though it were their own with a portion of their rent going towards a down payment (forced savings) and pays a fair price for it at closing so there is no animosity.