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What is Rent-to-Own and How Does It Work?

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What is Rent-to-Own and How Does It Work?
4 min. read

Image: Roman Samborskyi / Shutterstock.com

Rent to own, or RTO, isn’t so well-known in Canada, but as interest rates rise and the market hots up, it has been growing in popularity. It’s often seen as a way for those who don’t quite qualify for a mortgage or can’t gather the cash for a down payment, to take a step up on the property ladder. But what is it and how does it work? 

Read on to discover all you need to know about rent-to-own and see whether it’s the best choice for you.

What is Rent-to-Own?

As the name suggests, a rent-to-own home is one that the potential buyer will first rent as a tenant, before buying. This program can help the would-be buyer build up enough funds for a down payment, and create a high credit score in order to enjoy the best rates on their mortgage. It’s a useful route to homeownership for those that aren’t yet able to jump straight in or are keen to test the waters first.

How Does it Work?

It’s not quite as simple as paying a little extra on your rent each month in order to build up equity. Rent-to-own starts with a contract, which can come in many shapes and sizes. This contract is typically known as a rent-to-own agreement or a lease-option agreement. It will normally detail the agreed price of the home, the agreed lease period and the market rent price. Additionally, it’ll cover the following points:

Choices

The landlord/seller of the rent-to-own home you’re interested in may offer you a choice of contracts. The first, an option-to-purchase contract, will allow you to choose whether you want to buy the home at the end of your lease or not. This is the most flexible type of contract, and is ideal for testing a neighbourhood out before committing.

The second type is a lease-purchase contract, which ties you into the deal, and at the end of your lease, you’re obliged to buy the home. Many landlords favour the lease-purchase contract, as it almost guarantees them a buyer at the end of the program.

Up-front Fees

Regardless of the type of contract, you will be required to pay an up-front fee, which is typically around 2-5% of the current appraisal price. This will generally be added to your down payment at the end, or given as a discount on the final sale price. It’s like a large security deposit that lets the seller know that you’re serious about buying, and it encourages the buyer to commit to the program.

This fee may be refundable, at least partially, but you’ll almost always lose it if you don’t go through with the purchase, regardless of whether it’s an option-to-purchase contract or a lease-purchase contract. However, while there are two broad types of contract, the details of every individual contract are different, and it’s well worth going over yours with a professional.

Paying the Rent

With the initial fee paid up, the program can commence. You will typically pay rent monthly, though your payments will be higher than the market rate. For example, 75% of your payments may go towards the rent, while the remaining 25% is put towards your future down payment—a sort of forced savings plan. The typical lease will be between 1 and 5 years, providing ample time for you to fix a poor credit score.

End of Lease and Asking Price

Once your lease is up, depending on the type of contract you have, you’re either obliged to buy the home or you can choose to walk away. The idea is that, during the rental period, you would have built up enough funds for a healthy down payment, and have had time to fix your credit score.

The final asking price can be agreed at the beginning of the program and locked in, or agreed on at the end of the lease, when it will typically be the new appraisal price. Agreeing in advance is generally more popular among buyers, due to the frequent fluctuations in the market.

Now that you know what rent-to-own is and how it works, you might be tempted to jump straight in. However, as with everything in real estate, there are pros and cons, and potential risks if you go in blind. Before you make a decision, educate yourself and check out the benefits and disadvantages of rent-to-own.

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