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Pros and cons of rent-to-own

by Helana Mulder on 18 Feb 2022

Buying a home in today's market is not what it was like a decade ago. With high prices in the housing market and rising interest rates, saving for a down payment and paying off your mortgage are bigger tasks than they once were.

Even rent prices in major urban cities are making it harder for individuals, couples, and families to find affordable housing options. Cities like Toronto and Vancouver are notorious for extremely high rent prices for small apartments.

One option that has been rising in popularity over the last few years, especially for first-time homebuyers, is rent-to-own homes. But, just with any housing option, there are pros and cons that need to be considered and evaluated in order to determine whether this option is right for you.

What is a rent-to-own agreement?

A rent-to-own agreement is a housing option that has tenants make monthly rent payments with the option of purchasing the property down the road.

In many cases, a portion of the monthly payments go towards the original purchase price of the home. Your monthly rent can act as partial mortgage payments while you are still renting the property. During the terms of the lease, the tenant lives in the home and pays rent to the landlord who owns the home.

Two types of rent-to-own contracts

When it comes to rent-to-own homes, there are two main types of contracts that you should know about before signing an agreement.

In a lease option agreement, tenants have the right to purchase the home after the lease is up. On the other hand, a lease-purchase agreement requires that the tenant purchase the home once the terms of the lease are finished.

Before you agree to live in a rent-to-own property, you should talk with a realtor or the landlord about what kind of agreement is the best option for you. Make sure that you understand both of these options so that you avoid getting stuck in a contract or losing money.

Non-refundable option fee

When you decide to create a rent-to-own contract, there will be a non-refundable option fee that will be paid to the landlord at the start of the lease. This fee acts sort of like a down payment and gives you the option to buy the property in the future. Most option fees range between 1-5% of the home's purchase price and are negotiable between the buyer and landlord.

What are the pros of rent-to-own agreements?

As with any major decision, there are pros and cons that need to be evaluated before you continue with the plan. The rent-to-own housing option is no different.

This type of agreement is known for benefitting both the buyer and the owner, making it an attractive option. Here are some of the benefits of living in a rent-to-own home.

Build up credit and save for a down payment

A rent-to-own contract can work with people who have poor credit scores, making it an extremely attractive opportunity for those who don't have great scores or who haven't built up enough credit.

These rent-to-own lease options or lease-purchase agreements give the individual time to build up some strong credit and qualify for a mortgage during the rental period before purchasing the house.

Credit score and buying a house

Credit score is integral to buying a house and taking out a mortgage. If you have a bad credit score, banks, credit bureaus, and other loaning institutions will see you as a risky borrower and may be less likely to offer you a good rate on your mortgage or may not even lend to you at all.

One common exception to this is the FHA loans which are housing loans that can be obtained by individuals with scores in the 500 range.

A poor credit score can come from habitually making late payments or having too many missed payments, having large amounts of debt, maxed-out credit cards, or just not taking the time to build up a strong credit score. Having a specified period of time to prove that you are a reliable borrower can be exactly what some buyers need.

Save for a down payment

The price of a down payment in Ontario is usually around 20% of the purchase price. With home prices skyrocketing in the real estate market, this 20% can be quite large. This is why opting for a rent-to-own arrangement can be beneficial if you're saving for a down payment as it gives you a buffer of time to save that money.

Putting aside money each month will force you to save for the down payment that can come at the end of the lease term.

A chance to build up equity

A rent-to-own situation can also be an opportunity to start to build equity. While it's not like the traditional equity found in owning the home, the portion of your monthly rent payment that goes to the eventual purchase price can be seen as a way of investing in your future home.

Move in right away

Another benefit for tenants or buyers is that they can move into the home right away without waiting until the closing dates. This makes it easier for people who need a place to live right away or are moving for a job. The ease of access for these homes makes it a popular option for many individuals.

Lock in a house price

Especially with current housing prices, having a solid purchase price can be extremely beneficial. For a rent-to-own contract, buyers can lock in a purchase price for when they eventually buy the property.

Even if the monthly payment is high or the locked-in purchase price is a bit higher than the average home price at the moment, it can be beneficial to have a secure price in case the average rises. This can help buyers avoid any raised prices due to rising Federal Reserve Bank interest rates or the market gets hot.

What are the cons of rent-to-own contracts?

While many owners may see the benefits of rent to own agreements, there are still some drawbacks that you should consider in order to make the decision that is right for you.

Lease-purchase contract

In some cases, these purchase agreements can be the better choice over lease option agreements; however, you will have to make sure that you are willing and able to purchase the home after the term. If a tenant decides not to purchase the property after signing the agreement, they will lose the money that was accrued in your payments.

Watch out for scams

Some landlords or investment companies find ways to make their money off these kinds of properties and willing tenants. In some cases, these landlords and companies make the buyer responsible for paying off their debt with high rent prices.

This is why it's crucial to work with a professional real estate agent or a real estate attorney when looking for rent-to-own properties.

You could lock in a high purchase price

Right now, while the market is hot, home prices will be quite high. If you lock in a high price now and, by chance, the market price goes down throughout the rental term, you will be stuck paying more than what the property is currently worth.

Understanding market trends are talking to professionals can help you lock in a price that won't leave you feeling ripped off.

Other cons

There are some other miscellaneous drawbacks of a rent-to-own agreement. For one, the buyer must qualify for a mortgage at the end of the term or the agreement is nullified and the buyer may end up making an extra payment to reimburse the landlord.

As well, some contracts don't include a home inspection, meaning that you could uncover some faults in the home after you have signed the agreement.

If you're only looking for cheap monthly payments, this is not the best option for you. Because a portion of the payment goes to the down payment, it is likely that the tenant pays rent prices that are higher than the average rental payment in town. Ensure that you can afford these monthly rental payments as a missed payment can also nullify the agreement.

The bottom line

Like any real estate transaction, it's recommended that you talk with real estate agents before moving forward with a rent-to-own home. Real estate professionals are able to provide you with knowledge, advice, and insight in order to help you make an informed decision that fits within your financial goals.

Having a legal professional or lawyer review the lease agreement can help you feel more comfortable about the contract and can point out any flaws or errors in the contract that you may not see right away. Working with professionals can actually save you time and money in the long run, which is why it is so highly recommended to work with a real estate professional.

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