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The Pros and Cons of Rent-to-Own

Pros and Cons of Rent-to-Own

Real estate prices have been on a upsurge in Canada on a year-over-year basis up to as much as 10.3%. This has been the trend since the past few years, so much so that it has left many people struggling to keep up with their targets of purchasing a new home.

Unless you have ready cash for a down payment, like most home buyers, you are going to need a mortgage to finance the purchase of a new home. For that to happen, you need to have a good credit score, a down payment and some more specifications to qualify for lending. In the absence of any one of these, home ownership may seem a far-off possibility.

This is when a rent-to-home option becomes a viable alternative for many individuals.

What is rent-to-own?

If you are faced with a scenario where arranging for a down payment is a tough proposition, the option of rent-to-own may be what you are looking for.

Rent-to-own is an agreement between the tenant and the landlord where the tenant pays a specific amount as rent to their landlord, while setting aside a portion as down payment. Over time, the down payment grows and, eventually, the tenant is able to purchase the home outright off their landlord. In other words, this agreement allows you to rent a property for a specific time period, while also giving you the option to purchase it before your lease reaches its expiration date. A standard contract consists of two parts: the initial rental agreement, and then the option to purchase stipulation.

For many home buyers, this comes as a relief as they now can save up for a down payment and eventually buy the home that they rent.

Essentially, there are two agreements that the tenant and landlord get into. The first is a lease agreement and the second is an option to purchase agreement. 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, and the home purchase price. It would be advisable to get your lawyer look into the rent-to-own contract before signing into it.

The owner and tenant sign an “Option to Purchase Agreement”, where, for a fee, the tenant can live in the home and save up the required down payment, during a set period of time (let’s say 3 years). This fee, also known as the option deposit, ranges from 2.0-2.5% of the purchase price and is later deducted from the agreed purchase price. So, the tenant needs some cash up front, to get started.

While living in the home, the tenant must pay the agreed upon rent amount each month, as well as put additional funds aside for the 5% down payment due in 3 years. Ideally, these funds should be paid into an account that the landlord cannot access.

Pros of rent-to-own

  • Rent-to-home option allows you to purchase home even if you have poor credit score.
  • This option allows you to try the property before you buy it.
  • Rent-to-buy allows home buyers to address financial issues that are holding them back from obtaining a mortgage which is by far the main advantage of this option.
  • It gives property owners an opportunity to access more buyers
  • You can start living in the property immediately, as soon as you finalize the terms of the contact.
  • This option can help you find a home that you can eventually buy instead of having to move often.

Cons of rent-to-own

  • If you choose not to purchase the home that you enter into a lease-to-own agreement, you will likely lose all the money accrued toward a down payment.
  • A rent-to-own agreement usually comes at a higher purchase price.
  • If you wish to do anything to the property, you may not be able to as there may be restrictions.
  • You may have to take a financial loss if the property prices fall.
  • A single default in payment of rent could lead to nullification of the agreement
  • A rent to own agreement does not address all potential problems like any issues with the property. This can however be overcome by asking for a home inspection before entering into the lease-to-own agreement,
  • If one anyways fails to qualify for a mortgage at the end of the rental period, they may end up not being able to purchase the home
  • Although this concept of rent-to-own has benefits in the offering, it is very rare as there is possibility for landowners to lose out on potential appreciation of home prices as they have agreed to sell at a certain price earlier.

Advice from the professionals

Rent-to-own may seem quite a good proposition who are worried about property prices rising in the future and facing an issue of having to come up with a down payment. But, there is a word of caution though. Many homeowners nowadays include a clause in the contract that states, if home values rise significantly, tenants may have to pay more in the end. So, they eventually end up paying a high price!

Also, financial professionals do not recommend this option to home buyers unless this is the last resort available to them. Reason being – If the renter does not end up exercising their right to buy, they lose a lot more cash [the option deposit] compared to just renting and saving for a down payment on their own.

 

Rent-to-own may seem like a great buying strategy for people with low credit score or other financial issues. But, it may still take them some good number of years to get the financing done.

The word of advice given by professionals are however to try and solve all your financial issues before entering into such an agreement so as to ensure that this proposition works in the best way for you.

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