Rent-to-Own: Beware of the Risks
You may have come across Rent-to-Own properties during your house hunt. These deals are exactly as they sound – a homeowner rents to a tenant, and the tenant has the option to buy the home for a predetermined price at the end of the lease.
Ideally, this option would provide a mutually beneficial agreement for both the homeowner and the tenant – the homeowner has a deal to sell their house, and the tenant can then build their credit over time while also saving up for the down payment.
While this may seem like a great option when trying to get into the real estate market there are some risks that both homeowners and tenants need to be aware of before entering into this type of agreement.
More often than not, a lease option agreement like this will benefit the homeowner, as they can demand more money from the tenants than what others would normally pay if it was listed on the open market. Rent-to-own options are limited, and the homeowner can take advantage of their tenants’ poor credit, weak employment history, or simple desperation to get into the real estate market.
In most rent-to-own scenarios, the tenant will pay a higher than normal rent, with a portion going toward a down payment (essentially a forced saving plan). The tenant typically also puts down a deposit of about 5 per cent of the final agreed upon sale price – which is held by the homeowner as credit towards the price of the house at the end of the rent-to-own lease option.
While this may seem to be an attractive option for tenants who need to build up or fix their credit score, if they decide to break the rent-to-own agreement they may lose their 5 per cent deposit, or even all the money that was set aside for the down payment.
Depending on how the contract is written, the agreement might become void if rent is paid late at any time – meaning there’s not only a risk of being evicted, but also potentially losing tens of thousands of dollars that are now in control by the homeowner. Therefore, if you have a change in life circumstance – whether personally or financially – it can have a huge impact on both your ability to pay rent and sticking to your rent-to-own obligations, as well as your ability to purchase the house at all at the end of your lease.
Should anything happen – job transfer, large financial expenditure, or loss of work due to cutbacks or disability – the consequences can be devastating for the tenant. You are also trusting that the homeowner is paying the mortgage. Should they default on the mortgage the tenant would be left without a house to purchase, a place to rent, and the possibility that their deposit and savings towards the down payment won’t be returned in full (or at all!).
On the flip side, should the rent-to-own agreement be terminated, the homeowner is now left having to list their property on the market, either privately or with a real estate agent. If your tenants are being evicted they may no longer be cooperative when trying to do showings, and it can be a hassle having to give 24hours notice and show a property that hasn’t been properly cleaned or tidied.
If you have already made plans to purchase a new property it may be contingent on your current one selling first. Should your rent-to-own agreement fall apart you will no longer have the security of buyers already lined up. There is always the risk that it will take longer than expected to sell your house on the open market – this therefore risks your plans to purchase not coming together.
If you decide to enter into a rent-to-own agreement make sure to have your lease and any other paperwork reviewed by your lawyer. Your lawyer should be able to explain the pros and cons within your contract and help you foresee potential risks or problems before you sign.
Ideally, you might want to consider start an RRSP to save for the down payment, or some other savings plan that still leaves you in control of your money, or to continue renting until you qualify for a traditional mortgage.