A common question we’ve come across in the mortgage industry is how rent-to-own programs work and whether they are worth it for potential homebuyers. While your best bet is always to speak to a certified professional about your options, it is important to consider that there are alternatives to rent-to-own programs that may be more beneficial in the long-run.
How does Rent-to-Own work?
A rent-to-own program generally involves two agreements:
- Occupancy agreement (also known as the lease agreement) which is similar to the lease you would sign on any rental property.
- Option to Purchase OR Commitment to Purchase. The distinction between the option and commitment is important, as a commitment to purchase means you must buy the home at the end of your term or you will be in breach of your contract. An option to purchase, on the other hand, is a contract stating your intentions to buy the property.
The agreements typically include a 1-3 year term, where the purchase price of the home is set at the beginning by using the projected value of the home after the term is up. An initial deposit may be required.
The payment arrangement generally includes your base rent amount (plus any additional costs like utilities, if applicable) as well as a set amount that is a “credit” towards your future purchase. This arrangement acts as an automatic savings plan to build up the down payment for your home.
What Should I Know about Rent-to-Own?
- When your term is up, you are still required to qualify for a mortgage. You do not own the home until the mortgage process is complete and you have been fully approved.
- Because the purchase price is set at the beginning of the lease term and is based on ‘projected future value’ of the home, there is a risk that you will end up paying more than the home is worth if the market doesn’t perform as expected.
- Your agreement may be void if you make a late payment.
- Your deposit may be forfeited if you do not qualify for a mortgage or if you change your mind on purchasing the home. You may also lose the extra portion of your rent that was put towards your down payment depending on the terms of your agreement.
- There are very few mortgage lenders that offer rent-to-own products, and those that do may have their own specific set of criteria that you must meet in order to qualify. Please be sure to check with potential lenders to give yourself an understanding of their requirements before entering into a rent-to-own agreement.
An example from one of our lending partners includes the following criteria:
- That the property value be based on the sale price outlined in the Purchase Agreement and not on present value of the subject property.
- Only rent payments in excess of market rent (the amount of rent that can be expected for a property) are eligible to be put towards the down payment. For example, if market rent was $1200 per month and you pay $1500 per month, only $300 would be able to go towards the down payment.
- That the mortgage be insurable through one of Canada’s three default insurance providers (CMHC, Genworth or Canada Guaranty).
- The Rent-to-Own Agreement must not be current dated, and must include:
- That the agreement be registered on the title of the property (this is a common requirement across most rent-to-own lending products).
- A supporting letter by a certified appraiser done at the time the purchase agreement was made.
- A provision for the prospective purchaser to be entitled to some refund of the amounts set aside as down payment in the event the sale does not proceed (demonstrates purchase price is not being overstated to take into account the down payment).
- A confirmation that the purchaser(s) are entitled to refunds of amounts set aside as down payment.
If you cannot qualify for a mortgage through a traditional bank or lender because of bruised credit or a lack of credit history, alternative lending may be an option for you.
Additional options for accessing down payment funds include:
- A flex down mortgage where you borrow the required 5 percent as a loan or line of credit.
- Utilizing your RRSPs to borrow your down payment. First-time homebuyers and individuals with disabilities are eligible to access up to $35,000 under the federal Home Buyers’ Plan.
- Establishing an automatic savings plan. The extra funds that would have been added to your rent as a ‘credit’ towards your future purchase can be put into a savings account, which allows you to collect interest on the money over time.
If you need help establishing a plan for home ownership, we are happy to help! Our Brokers can sit with you one-on-one, look at your financial scenario and assess the steps it would take to get you into a home. Contact our office today for a complimentary consultation.