How rent-to-own programs work

Owning a home has long been every Canadian’s dream.  However, with rising home prices, many would-be homebuyers have not seen their income levels caught up to the fast appreciation in property values.  

For most, buying a home is now out-of-reach because of the larger down payments required, as well as income levels needed to qualify for a mortgage.Enter rent-to-own programs.  Rent-to-own programs are not new.  They have long been an option for owning your dream home, even though you may not have a hefty down payment saved or are able to qualify for a mortgage.  Rent-to-own is a unique way of owning a home where you rent a property for a specified period and then have the option to purchase it at the end of the rental term.

This program can be an excellent option for those who want to own a home but may not be able to secure a mortgage or afford the down payment.Let’s take a closer look at the rent-to-own program, its benefits, and its potential drawbacks.

What is Rent-to-Own Program for Homes?

The rent-to-own program for homes is a contractual agreement between a tenant and a landlord where the tenant rents the property for a specified period and then has the option to purchase the property at the end of the rental term. In a Rent-to-Own arrangement, the rent paid by the tenant during the rental term is usually higher than the market rent, however, a portion of it goes towards the down payment or purchase price of the property. The amount of rent that goes towards the purchase price is usually negotiated between the tenant and landlord.

How does Rent-to-Own Work in Canada?

The rent-to-own program in Canada typically works as follows:

‍Draft and Sign an Agreement The tenant and landlord negotiate and sign a contract that outlines the terms and conditions of the rental agreement, including the rental amount, the length of the rental term, and the purchase price of the property.

‍Paying an Option fee The tenant pays an option fee, which is a non-refundable fee that gives the tenant the option to purchase the property at the end of the rental term. This fee is usually a percentage of the purchase price and is credited towards the down payment if the tenant decides to purchase the property.

‍Paying Rent The tenant pays rent to the landlord, which is usually higher than the market rent. A portion of the rent is credited towards the down payment or purchase price of the property.

‍Purchase the Property At the end of the rental term, the tenant has the option to purchase the property. If the tenant decides to purchase the property, the option fee and a portion of the rent paid during the rental term is credited towards the down payment.

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The Benefits of Rent-to-Own Program

A rent-to-own program can benefit both the tenant and the landlord if done right.  Here are some of the benefits to the tenant.

‍No mortgage while building equity. The rent-to-own program is an excellent option for those who may not be able to secure a mortgage or have a low credit score. The program allows tenants to live in a home and build equity while working towards purchasing the property.

‍Flexibility The rent-to-own program offers tenants flexibility in terms of the rental term and purchase price. Tenants can negotiate the terms of the rental agreement and purchase price with the landlord to ensure that it meets their needs.

‍Runway to save for a down payment The rent-to-own program allows tenants to save for a down payment while they rent. This can be beneficial for those who may not have enough money for a down payment upfront but can save over time.

Potential Drawbacks of Rent-to-Own Program

Higher rental payments The rent paid during the rental term is usually higher than the market rent. This can make it difficult for tenants to save money for a down payment or to afford the rental payments.

‍No guarantee of purchase The rent-to-own program does not guarantee that the tenant will be able to purchase the property at the end of the rental term. If the tenant is unable to secure a mortgage or cannot afford the purchase price, they may lose the option fee and the portion of the rent that went towards the down payment.  This needs to be a key consideration for anyone entering a rent-to-own agreement as the financial losses can cause a significant setback and the tenant may essentially walk away with nothing.

‍Responsibility for maintenance Tenants in a rent-to-own program are usually responsible for the maintenance of the property.  Some rent-to-own companies may impose that all maintenance work is done (and paid for) by the tenants, as if it the tenant was already the homeowner.  The renter will eventually be buying the home, so they might as well be paying for the home’s upkeep and maintenance. However, based on your agreement, you can be restricted from certain actions, such as renovating the home or even painting the walls of a room. You will need permission from the rent-to-own company in order to make changes or alterations to the home before you have actually purchased the home.

‍Limited choice of homes Rent-to-own programs are not widely available in Canada, and the inventory of properties available for rent-to-own can be limited.

‍Potential for landlord to change terms The landlord has control over the terms of the rental agreement, including the rental amount and purchase price. This means that the landlord may change the terms of the agreement during the rental term, which can affect the tenant's ability to purchase the property.

‍Home price change If home prices change more or less than the expected change in your agreement, it will impact whether purchasing or not purchasing would be a better choice. If home prices increase more than the rate that you locked-in (in your agreement), then purchasing the home would allow you to gain that appreciation in price.

On the other hand, if home prices decrease, your locked-in price would be more expensive. At a certain point, it may be better to not purchase the home.

Walking away without purchasing the home If you choose not to purchase the home, you will lose your option fee and the rent credits that you have paid towards. If during the period of your rent-to-own agreement, house prices have also increased, it means any house that you purchase now will be more expensive then if you had purchased it earlier.

Is Rent-to-Own Right for You?

The decision to participate in a rent-to-own program should be carefully considered. If you have a low credit score or cannot secure a mortgage, and are willing to pay a higher rental amount, rent-to-own can be an excellent option for owning a home. It can also be a good option if you need time to save for a down payment, and the property you want is not currently available for purchase. However, it is essential to understand the potential drawbacks of the program. You should make sure that you have a clear understanding of the rental agreement, including the rental amount and purchase price, and the conditions for purchasing the property. It is always a good idea to have your agreement reviewed by a lawyer prior to signing it.  You should also ensure that you can afford the rental payments, the option fee, and the down payment required to purchase the property.

The bottom line

Rent-to-own programs offer a unique opportunity for tenants to own a home while they rent. It can be an excellent option for those who cannot secure a mortgage or need time to save for a down payment. However, the program has potential drawbacks, including higher rental payments, limited inventory, and the potential for the landlord to change the terms of the agreement. If you are considering a rent-to-own program, it is essential to do your research and understand the terms of the rental agreement before signing. You should also consult with a financial advisor or a real estate lawyer to ensure that you are making an informed decision. Ultimately, rent-to-own can be a great option for those who are willing to pay a higher rental amount and are committed to owning a home in the long-term.