The pros and cons of rent-to-own

By Mark Weisleder - a lawyer, author, instructor, columnist and keynote speaker for the real estate industry.
Original article can be found here

The changes to the mortgage rules announced by Finance Minister Jim Flaherty last July are making it more difficult for first time buyers to get approved for a mortgage. Other buyers may have good credit but not enough of a down payment. At the same time, landlords are looking for good tenants to rent their units. Rent-to-own may provide a win-win for both owners and tenants.

Here’s how it works:

A landlord rents the home or condominium under a basic home lease. For an extra payment, the tenant receives an option to buy the home at a later date, for a set price. Let’s say the home is worth $250,000. The parties agree the tenant will have the right, but not the obligation, to buy the house in three years for $280,000.

The fee for this right, or option, is usually 2 or 2 ½ per cent of the final price. In this example, 2 percent of $280,000 would be $5,600. Then, each month, the tenant pays an extra fee, say $200, that also is applied to this option price. At the end of the three-year lease term, the tenant has put up close to 5 per cent towards the purchase price option. In this example, it would be close to $13,000.

If the tenant exercises their right to buy, they can use the $13,000 as the down payment and apply for a mortgage to finance the rest of the purchase.

Here are some of the advantages for the tenant:

•You may not have the down payment now, but you will have it at the end of your lease, as a result of the additional payments;

•If your credit is not good, you can improve it by making timely payments of rent;

•You can try out the neighbourhood and if you change your mind later, you can just cancel the option;

•If the market price of this home is more than $280,000 at the end of your lease, you still get to buy it for the same $280,000.

•If the market collapses and the home is worth less than $280,000, you do not have to go through with your purchase.

Here are some disadvantages:

•There is no guarantee that a bank will give you your financing when you exercise your option. You still have to improve your credit score or find someone to co-sign your application;

•If you don’t go ahead with your purchase, you usually have to forfeit the option payment.

Here are some advantages for the landlord:

•Tenants on rent-to-own typically take better care of the property, thinking that they may own it one day;

•Your profit is fixed at the time of the option.

Landlords need to make sure that the option payment is covered in a separate agreement, and is not included in the lease. If it is included in the lease and then the tenant defaults, it can be harder to evict the tenant from the property. Landlords also need to conduct a thorough credit and background check, to make sure that the tenant looks like they will have the means to make all of the required payments.

Rent to own can work for landlords and tenants if you are properly prepared in advance.