As interest rates soar and lenders make it harder than ever to get a mortgage, more and more would-be homeowners are turning to rent-to-own programs. Check out our introduction if you don’t know what rent-to-own is or how it works.
As with anything in real estate, there are pros and cons to rent-to-own programs, and it’s worth going into the deal with your eyes open. Both buyers and sellers have a lot to gain from such a program, and if all runs smoothly, it’s a win-win scenario. However, things don’t always go to plan, and there are a number of risks involved.
The Pros & Cons for Buyers/Tenants
By and large, rent-to-own programs are geared toward would-be homeowners who are unable to qualify for a mortgage, or who don’t yet have the savings for a down payment. There are numerous benefits to this way of living, and the program is also popular with other niche groups, such as divorcees. It’s not without risk, though, and if you’re not prepared you could end up in financial and even legal trouble.
- An option-to-purchase contract is flexible and can allow the tenant/buyer to give a house or neighbourhood a test run. They can cancel the contract at any time and aren’t obliged to buy at the end of their lease.
- Poor credit scores can be rectified while ensuring the house you want is still available when you do qualify for a mortgage.
- Saving for a down payment becomes much easier, as a portion of your rent will go towards it each month.
- Locking in the asking price ensures you pay the same price, even if property values rise in the meantime.
- You have more flexibility than most tenants and are typically able to renovate, decorate and maintain your home as you like.
- On a lease-purchase contract, you’re tied into the sale, even if you still don’t qualify for a mortgage at the end of your lease. You risk losing any sweat equity or savings you’ve put into the home.
- With an option-to-purchase contract, if you decide not to buy the house, you’re still obliged to pay the initial fee.
- Repairs and maintenance are typically the responsibility of the landlord, but with rent-to-own, the tenant is expected to take responsibility.
- The house is still in the landlord’s name and if they default on the mortgage payments, there’s a chance the home could go into foreclosure.
- Strict landlords can enforce harsh terms and penalties for late payments — check your contract!
- If the asking price is locked in and prices drop, you will be obliged to pay more than the market price.
- Money spent on rent is money you’ve invested into the property that you might never make a return on.
The Pros & Cons for Sellers/Landlords
While mainly aimed at buyers, there are several benefits to be reaped for the seller of a rent-to-own home. The risks to the seller are fairly small, but they do exist and can cost if one is not careful.
Advantages for Sellers
- Potential to make a good profit on rental payments and sale price.
- The seller isn’t typically responsible for repairs and maintenance.
- Low-risk venture, since even if the tenant doesn’t agree to buy, you’ve still earned their rent plus the initial fee, and can find another buyer.
Disadvantages for Sellers
- Sellers cannot go straight to market, and must spend time vetting and selecting a good tenant.
- With an option-to-purchase agreement, tenants can terminate the contract at any time, meaning the seller must repeat the process of finding another tenant.
- If the asking price is locked in and house prices rise, you could be leaving money on the table.
- The seller must still make mortgage payments, which might not always be comfortably covered by the rent.
Making it Work
Rent-to-own can work for both seller and buyer, but both need to go into the program with their eyes open—the help of real estate professionals and even financial advisors can be invaluable. Contracts should be studied by a legal professional before being signed, and any discrepancies cleared up. It’s vital that all parties are on the same page.
On top of that, you need to do the math and see if it really does work in your favour. While locking in a price offers stability, it might not pay off in the long run. Think about how much you will put aside each month, and whether you might be better off in a normal rental before looking to buy.
The major risks for the tenant/buyer are that they still won’t qualify for a mortgage at the end of the lease term or that the conditions aren’t good. Being locked into a deal that is so dependent on something you have little control over can lead to financial loss, a risk that is very real as lenders tighten up regulations.