Amid high prices, stiff competition, and strict qualification requirements, it’s hard to find a house that you like and can afford. A rent-to-own arrangement can be an alternative path to home ownership in certain situations. But because it’s a relatively uncommon in Canada, it’s important to understand how it works and what the risks are before deciding if it’s right for you.
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A rent-to-own agreement (sometimes called a lease-to-own agreement) is a contract between you and a landlord or rent-to-own company. In general, you agree to rent the home for a set period, usually one to five years, with the intention of buying it. As part of the agreement, a portion of the rent (known as a “rent credit”) is put aside by the landlord with the understanding that it will go towards an eventual down payment when you purchase the home. You may have to pay extra, on top of the market rent, to earn this rent credit.
Some people who enter into a rent-to-own agreement assume that their full rent payment is applied toward the eventual home purchase, and that they are paying for the property over time, but this is not accurate. Under most rent-to-own agreements, you will likely still need to have cash for the rest of the down payment and qualify for a mortgage in order to buy the house..
Depending on the kind of contract you sign, you may have the option to buy the home at the end of the rent-to-own agreements, or you may be obligated to buy the home (and pay a penalty if you don’t).
» MORE: How much house can I afford?
There are generally two kinds of rent-to-own agreements: a lease-option agreement and a lease-purchase agreement. They both have distinct obligations and expectations.
With a lease-option agreement (also known as an option-to-purchase agreement), you rent the home for a given period and, if your contract stipulates it, some money from your rent may be set aside for a down payment.
You will also be expected to provide a non-refundable deposit (1% to 5% of the property’s asking price) to secure the right to make an offer to buy the home in the future.
At the end of the rent-to-own agreement, you’ll have the option to buy the home but are in no way obligated to do so. However, if you choose not to buy the home, it’s unlikely you’ll be refunded the deposit or the rent money that was set aside for the down payment. It all depends on the terms of your agreement.
With a rent-purchase agreement, you commit to purchasing the home at the end of your rental agreement. You also provide a deposit and have a portion of your rent money set aside to be put towards payment for the home. At the end of the contract, if you renege on your agreement to buy the home, you’ll forfeit the extra rent money and deposit, and may even pay additional fines, depending on the terms of the agreement.
It’s crucial to note that every rent-to-own agreement is different, so it’s important to read the contract carefully and consider having a lawyer review it to ensure you fully understand your rights and responsibilities.
Ontario law mandates that there must be two separate rent-to-own agreements between renters and their landlord.
One agreement is an option-to-purchase agreement, which must contain information like the final price of the home and the number of monthly payments the renters must make.
The second agreement is a lease agreement that must conform to Ontario law. It needs to include monthly rental amounts, the date the lease expires and what services are or are not included in the rent. It’s important to have a lawyer go over the rent-to-own agreements to ensure they conform to Ontario regulations.
Rent-to-own alternatives worth looking into include some of the government programs to help first-time home buyers afford a home (such as the First-Time Home Buyer Incentive), You may also consider getting someone, like a parent, to co-sign your mortgage.
Often rent-to-own homes appeal to people who don’t yet qualify for a mortgage because they don’t have enough of a down payment, or they have issues on their credit report. However, not qualifying for a mortgage is usually a good signal that you’re not yet financially ready to buy a home. It might be a better idea to save up more of a down payment or look into government programs that make home ownership more affordable.
Sandra MacGregor has been writing about personal finance, investing and credit cards for over a decade. Her work has appeared in a variety of publications like the New York Times, the UK Telegraph, the Washington Post, Forbes.com and the Toronto Star. You can follow her on Twitter at @MacgregorWrites.