Rent-to-Own a Home: Beware the Risks

Excerpted from The Toronto Star- Moneyville
Rent-to-own a home: Beware the risks
By Krystal Yee
September 10, 2012

Last year , as I was buying my first home in Vancouver, I came across a handful of listings offering rent-to-own or lease options on homes.

These deals as exactly as they sound – a homeowner rents to a tenant and the tenant has an option to buy the home for a predetermined price at the end of the lease.

On the surface, it seems like a mutually beneficial agreement for both parties - the homeowner has a deal to sell the house and the tenant can build their credit over time while saving up for the down payment.

However, Frank Petriglia, a real estate broker with RE/MAX Premier Inc. in Vaughan, believes that more often than not, a lease option agreement benefits the homeowner.

"The homeowner clearly comes out ahead in the rent-to-own scenario since they have very little on the hook," he says. "Since the selection of these types of units is slim, the homeowner can demand more money than the open market will be willing to pay. And my feeling is that it will stay this way regardless of market conditions."

In most rent-to-own scenarios, the tenant pays higher than normal rent, with a portion of the money going towards a down payment. The additional rent acts as something of a forced savings plan for the tenant, Petriglia says, adding that the option does give some people a way into the market, albeit at a slightly higher cost.

Tenants are also typically required to put down a deposit of about 5 per cent of the final sale price – which will be held by the homeowner as credit towards the price of the home at the end of the lease option.

Here's an example: A homeowner wants to sell for $200,000. The house typically rents for $1,000 a month. After a $10,000 deposit, a rent-to-own tenant might pay $1,300 a month in rent – with $300 of each payment as a credit towards the down payment. On a three-year lease, the tenant would have paid $10,800 towards the down payment. Add those credits to the initial deposit, and the renter will have $20,800 for a down payment.

This can be attractive for those who can afford to buy a home, but might not quality for a mortgage. This could be because of a weak credit score, or insufficient employment history. Their hope is that, by the end of the lease agreement, they will be able to qualify for a traditional mortgage from a bank.

Related: Lessons learned from a year as a home owner

The downside is that if a tenant decides to break the rent-to-own agreement, or decides the property is not suitable, they may lose their deposit, and depending on how the contract is written, may lose all the money that was put aside for the down payment, or they might receive a very small portion back.

Additionally, in some cases your agreement may be void if you are late on rent at any time – meaning not only do you get evicted, but you could also potentially lose tens of thousands of dollars.

Petriglia suggests that many people looking to enter into a lease agreement would be better off renting and waiting until they can qualify for a traditional mortgage instead.

“I would rather see a homeowner start an RRSP to save the down payment, take advantage of the tax credit, then cash it out for the down payment and replace the money within 15 years,” he suggests. “By taking this route, you’re still in control of your money.”

However, if you do decide to enter into a rent-to-own agreement, it is important to get a lawyer to review any contract, and explain the pros and cons before you sign on the dotted line.

“It could cost you tens of thousands of dollars for a mistake, but it costs $500 or less to have the contract reviewed up front.” Petriglia warns.

Related: Finally! A renter’s market for condos

Rent-to-own home ownership can be risky for those who don’t understand exactly what they are signing up for.

“A change in life circumstance – whether personally or financially – can have a huge impact on your ability to continue paying that rent premium or sticking to your rent-to-own lease obligations,” Petriglia says. “Should anything happen, the consequences can be devastating.”

Have you ever considered rent-to-own home ownership?

Krystal Yee lives in Vancouver and blogs at Give Me Back My Five Bucks and Frugal Wanderer. You can reach her on Twitter (@krystalatwork), or by e-mail at krystalatwork@gmail.com.