You may be wondering how exactly renting to own works. Well, basically, a portion of your monthly rent goes toward purchasing the home. The actual terms of the agreement will vary depending on where you live and who you are renting from, but your rental agreement specifies that you intend to purchase the home at the end of the term.
The portion of your remaining rent credits, as well as any down payment, will have to be paid at the end of the term. While this process doesn’t necessarily eliminate upfront payments, the amount required is significantly less than a typical down payment. By paying the majority of any down payment over time, you reduce upfront costs and live in what could be your forever home.
What are the Types of Rent-to-Own Agreements?
When it comes to rent-to-own (RTO), there are two main types of agreements: lease option and lease purchase.
The lease option agreement allows the tenant to decide at the end of the term whether they still want to purchase the property. This agreement does prevent the seller from selling to someone else. The choice is completely up to the buyer. That said, the money put toward the down payment is to be kept by the seller. This means that money is now just considered rent.
The lease purchase agreement means that the tenant agrees to purchase the property at the beginning of the rental agreement. This is the most commonly used contract because it guarantees the homeowner a buyer. This also protects the buyer since the seller will be unable to sell the property to anyone else. The only situations in which the buyer can back out are the inability to secure the money from the bank. The agreement can also be ended if there is a breach of contract.
With both types of agreements, the purchase price is set at the beginning of the contract; even if the home’s value changes, you will have to pay the previously agreed-upon amount.
Renting to Own in Different Provinces
When you are renting to own in Canada, the process is relatively the same no matter where you live. There may be some minor distinctions by province, but in general, the process is the same. Two types of agreements are available when you rent-to-own.
Which one the seller chooses will depend on their preference. In some provinces, one standard agreement is used more than the other, but whether you are in Ontario, Alberta, Nova Scotia or even B.C., the basic laws are the same. This is the case in any province, really. Rent-to-own properties in Canada are still pretty rare, so there isn’t a ton of distinction.
When you choose to rent-to-own in Canada, you will be asked to sign two separate agreements. One is the rental agreement, and the other is the rent-to-own agreement. These can be done either directly with the owner or through a rent-to-own company. No matter how you do it, the terms of both the rental and the RTO agreement will be listed here.
With most RTO contracts, you are required to put a down payment. How much that payment is, though, depends on the agreed-upon sale price and the percentage the seller chooses. In addition to this down payment, there is another fee.
This is called the rent-to-own option fee and is usually between 1% and 5% of the purchase price. This fee essentially buys you the option to purchase the property in the future. Keep in mind, though, the lower the down payment and option fee are, the higher the rent payments could be, as well as the remaining down payment at the end of the term.
When it comes to the term of the contract, the length is normally somewhere between 1 and 5 years. The most common length for rent-to-own properties in Canada is 3 years. As we mentioned, with the average contract, regardless of length, the purchase price is usually based on the home’s current value.
In some cases, the seller may choose to include in the contract that it is to be based on the property’s future value. No matter which option is chosen, this also helps them to decide on the rent payments and your rent credits. These are usually 15-25% of the rent payments.
Maintenance on Rent-to-Own Properties
Maintenance is one reason RTO properties can be more expensive than purchasing them in the traditional way. In the case of rent-to-own repairs, property taxes, and other fees, they are usually paid by the prospective buyer. This is often negotiated into the contract before the agreement is finalized. When considering a rent-to-own program, these are the fees you need to consider before you agree to anything.
What are the Pros and Cons of Renting to Own?
Renting to Own instead of just renting is a big decision. Before you decide, you want to be sure you have all the necessary information. We have put together some of the positives and negatives of rent-to-own in Canada.
Pros
The main draw of rent-to-own is that it allows the buyer to improve their finances while living in their future home. It also allows you to fix your credit during this process. You don’t have to come up with the entire down payment right away, and it allows you to save more money to help with your mortgage approval when it comes time to purchase.
Cons
Even though there are some positives to renting to own, there are also some negatives you should consider. This is because the circumstances are substantially different from the traditional method of purchasing. With a rent-to-own agreement, you cannot get a home inspection before signing unless you negotiate it in. This could lead to many issues in the future.
With an RTO property, if you choose to back out of the agreement or miss a payment, you could lose all of the money that you have already sunk into the purchase. In some cases, this situation could hinder your finances more than help them.
The final thing you should consider before entering into a RTO agreement is that the finalization of the agreement is contingent on you qualifying for a mortgage. Even if you meet all of the other requirements and make all your payments, if you don’t qualify, you will lose everything that you invested into the home.
Contract
When you are signing a rent-to-own agreement, keep in mind that it is likely to be a longer, more detailed document. This is done not only to protect the seller’s interests but also the buyer’s. The contract will specify the terms of the agreement; if any are breached, the contract will be void.
Things that can be included in the contract are:
- Property address
- Property description
- Who is responsible for what fees and maintenance (usually the buyer)
- Down payment amount and option fee
- Purchase price
- Rental amount
- Rental credit amount
- Important dates, such as the last day to purchase the property
Low Monthly Payments on Rent-to-Own Homes
When it comes to rent payments on a rent-to-own, you actually pay above market rental prices. This is because part of your rent is going towards your down payments. For this reason, RTO properties can be more expensive in the beginning. The more you put towards your down payment, the less you will pay in the long run.
Rent to Own for Sellers
Renting to own is the same for buyers as for sellers; there are many positives, but also many negatives. Before you choose to rent-to-own your home, make sure you understand the risks as well as the rewards.
Pros
This process comes in handy for those who are having a hard time selling their home or don’t want to lose money waiting for a buyer. This process allows you to secure a buyer who may not otherwise be able to purchase the property.
With this process, you get a nonrefundable deposit on the property. You can still collect your monthly rent payments, as well as the deposit amount, which will be set aside. Even though the buyer can back out after the term of the agreement, most buyers avoid doing so since they have already sunk so much money into the property.
Cons
One major downside of an RTO agreement is that, while the agreement is in place, you still own the home, so you remain responsible for many things attached to it. In most cases, the renters will take care of things, but that isn’t always the case.
You also have to keep in mind that the home may not be kept in the same condition as when you rented it. If this is the case, it only becomes an issue if the prospective buyers back out of the agreement or miss a rent payment, and the agreement is terminated.
Under an RTO agreement, the agreement is finalized once the bank approves the loan for the property purchase. If this happens, the prospective buyer is often released from the agreement without penalty. You do get to keep all the money, but you then have to find another way to sell your home. It could have potentially fallen in value since then, and you could lose more than you gained.
How Do You Prepare For a Rent-to-Own Purchase?
If you are looking at renting to own because you don’t qualify for a current mortgage, that’s okay. A rent-to-own can help make your goal of owning a home become a reality. That being said, you don’t want to fly blind into an agreement like this. You could lose a lot of money.
Before you enter into a rent-to-own agreement, you should speak with a mortgage broker. Mortgage brokers will be able to help you break down what you can afford, as well as give you advice on what you need to do to be able to purchase in the future. You can also speak to real estate agents and a lawyer to get advice on what the best option is for you.
Keep in mind that when you are entering into a rent-to-own agreement, you are allowed to negotiate, as we mentioned. With some contracts, you may be required to pay the remaining down payment right before the purchase. You can negotiate to have the remaining down payment added to your rental amount. This means that at the time of purchase, you should have the total down payment and just need to complete the purchase.
When you are looking into rent-to-own, just keep in mind that you can do your research, get advice, and talk to professionals. When you are investing that much money in a home, you want to make sure you can finalize the contract.
Renting to Own Through a Company or an Individual
As we mentioned, there are two ways you can rent-to-own a home. The first way is by negotiating with a current or potential landlord. Keep in mind that even if you are negotiating privately, you still want a legally binding contract. This protects both you and the seller from losing any money.
With a private contract, there is going to be more risk involved, so you do want to make sure that you not only read the contract correctly before agreeing to it, but also make sure the contract is legal and get a second opinion if you need to. This is a lot of money you are going to be investing, so you do want to make sure that both parties are protected.
With a rent-to-own company, it won’t hurt to do the same. It is still the same amount of money, and you want to make sure that you are protected. If you are working with a rent-to-own company, they often have houses listed online that are available for RTO. These properties will also have listed prices.
With rent-to-own companies, it is in their best interest for you to complete the sale. Because of this, they will often help you to secure a mortgage. If there are specific roadblocks in your way that could affect your approval odds, such as a low credit score, these companies are often able to help you. They do what they can to get you approved for the mortgage and often work with lending companies. In some cases, your approval odds could be better with a rent-to-own company, simply because of the added layer of support.
Is Renting-to-Own a Good Idea in Canada?
While the path to ownership with rent-to-own isn’t a traditional one, the lease-to-own option can be a great option for potential property owners. That said, there is often more risk involved, and it has higher interest rates. While it isn’t a bad idea, it’s important to pay close attention to the contract before you sign anything.
The Disadvantages of Renting to Own
When you sign up for a rent-to-own agreement and want to buy the rental property over time, with rental payments credited toward the purchase, it’s important to note that there are risks involved. One of the biggest risks is failing to qualify for a mortgage when the lease period ends. This can range from one to five years; for many contracts, a three-year period isn’t uncommon.
If you have to walk away from the mortgage before you complete the purchase, you’ll lose your non-refundable option fee as well as any extra rent credits that were saved towards the down payment. This can add up to a lot of money since the payments are 15% to 30% higher than the standard market rent.
Another risk with a rent-to-own agreement is that the agreed purchase price is locked in at the start of the contract. This is often locked in for one to three years with an initial deposit, often referred to as an option deposit. If the housing market drops so your purchase price is now above market value, the obligation to buy remains.
In many rent-to-own agreements, maintenance and repairs are the responsibility of the prospective owner, even though they’re technically a tenant. This is different from a standard rental agreement, where the landlord is responsible.
The Cost of the Option Fee on Renting to Own
When you choose the lease option, the upfront option fee ranges from 2% to 5% of the predetermined price. This is stipulated in the contract, along with the end of the lease agreement and your future down payment.
Before the contract is complete, you will have to prove that you have a stable income. Having the agreement in place allows you to get mortgage-ready by meeting the income requirements and improving your credit score. It also gives you time to deal with any negative credit history.
Are Rent-to-Own Companies in Canada Legitimate?
In Canada, there are legitimate companies that help with the rent-to-own process. That said, the industry is still largely unregulated, so there are still a lot of predators out there. This is especially because private companies and landlords run all of the programs. Given current housing affordability, many prospective homeowners aren’t mortgage-ready, so these companies are becoming more popular.
Aspiring homeowners looking to build equity may choose this option instead of a traditional mortgage. It allows you to exercise your option to buy based on the current property value. However, there is no guarantee of mortgage approval when the lease agreement ends.
Renting to Own With Bad Credit
When you have bad credit, a rent-to-own program in Canada is a great way to get ready for a traditional mortgage. Many first-time buyers and self-employed individuals use this to continue paying rent while making payments toward a future purchase price.
The initial down payment goes toward your future purchase, and you can extend the lease term to increase your monthly savings. Traditional employment isn’t necessary to get pre-qualified, but an employment letter can help with your mortgage options. However, even if you have enough money, it’s important to use credit tools to improve your score to make you more desirable to lenders.
Is There a Government Rent-to-Own Program in Canada?
Currently, there are no government rent-to-own programs in Canada. However, there used to be the CMHC Affordable Housing Innovation Fund. Through the CMHC, the federal government had a dedicated rent-to-own program that provided loans and grants to housing providers and non-profits.
What Happens to Rent Credits if You Don’t Purchase?
When you’re in a home rent-to-own agreement, and you don’t end up finalizing the purchase, you can lose all of your rent credits and your option fee. The contract explicitly states that these amounts apply only if the contract is finalized.
How Rent-to-Own Works for Newcomers
As a newcomer to Canada, you’ll find the same rules apply to a rent-to-own agreement. While you improve your credit score, you can still make payments towards your home purchase. It also allows you to save money toward your home’s purchase price while still living in your dream home.
While an upfront payment is required, there are still unexpected costs associated with rent-to-own agreements, such as responsibility for repairs. This can add up since there are often minor repairs.
Rent-to-Own Vs. Saving for a Down Payment
When you’re deciding between the two, you’re deciding between immediate housing stability and financial stability. If you decide to rent-to-own, you are choosing homeownership, even if housing prices fluctuate. While a large down payment isn’t required, you will have to pay a percentage of the home price, and the payment structure will determine how much of your monthly payments will go towards the housing costs.
When choosing to save for a down payment instead, you can rent an apartment separately and use the rest of your funds to save for a home in a registered savings account. When you do purchase a home, you will go through the entire process right away with a locked-in price. There’s no risk of the price dropping while the contract is being finalized.
With both options, a steady income is required, and you will have to pay closing costs. If you’re renting to own, you’ll need tenant insurance until you own, then you will have home insurance.
Rent-to-Own Scams and Red Flags
Unfortunately, rent-to-own scams are common. Often, fake or dishonest owners will trick you into paying upfront fees and inflated rent when they either don’t own the property or line the contract with hidden stipulations and fees.
Some red flags to watch for include:
- Refusal of in-person tours
- Pressure to sign immediately
- Unusual payment methods
- Vague or missing paperwork
- Suspicious numbers
Example of Rent-to-Own Costs on a $500,000 Home
A rent-to-own agreement on a $500,000 home is usually about 3 years. For a 3% upfront fee, you’re looking at $15,000 due upon signing the contract. In terms of rent, you’d be looking at about $2,800, which includes a rent credit of $500. After 3 years, the total accumulated towards your down payment should be $33,000.
Getting Mortgage Ready Before the Lease Ends
If you’re in a rent-to-own agreement, you should start planning as early as a year before the lease ends. It’s recommended to speak to a mortgage broker who can let you know whether you qualify for a traditional mortgage or a private one.
When looking for a mortgage, you should show how much rent credit your contract allows to prove your down payment. You should also pay down your other debts to improve your credit score and reduce your debt-to-income ratio.
