Rent-to-Own

[Property Manager DB]

I wanted to start a discussion about rent-to-own to discuss how it works, the advantages/disadvantages and hopefully have some CP-ers share their experiences.


Defined
Rent-to-own can be a very complicated agreement but generally here's how it works.
The rent-to-own (also known as lease-to-own) process works similarly to a car lease. The Tenants pay their agreed upon rent every month and at the end of a set period (usually 36 months), they have the option to buy the house.

Each month of rent from the Tenant is income for the seller, but a portion goes towards a down payment to eventually buy the home. This portion is usually above and beyond the Owner's mortgage and operating costs.

I cannot stress enough that both the Tenants and the Owner need to be very clear about the contract/lease they draw up before they sign and agree to this arrangement.

[CaptainCrunch]

I was curious about this as well, it was something that I was interested in looking at from a buyers perspective.

Isn't the idea an accumulation of the downpayment of the house or more often the condo over the 36 months or more, so isn't it usually rent plus agreed upon downpayment/months of the agreement.

It sounds fairly expensive.

[Frequitude]

Unless the terms are very favorable to the renter (fair market value future price, low deposit, an amount of the rent going towards principle which implies a fair interest rate), they are a terrible idea. And a seller will almost never agree to those terms.

In my opinion they're a form of predatory lending when the buyer can't get traditional financing.

They're basically a call option on housing that usually end up having too high of a strike price and too high of an effective interest rate.

Isn't the idea an accumulation of the downpayment of the house or more often the condo over the 36 months or more, so isn't it usually rent plus agreed upon downpayment/months of the agreement.

Do they not also traditionally have an up front deposit that is forfeited if the buyer/renter doesn't end up buying the house. That's the part that makes it expensive.

[CaptainCrunch]

Yeah, just out of interest I was looking at some properties and they were all looking at 8 to 10k in a deposit, and the rent was still fairly high.

I don't understand the benefit, if you're just buying a condo for example that 10k would probably be you're normal down payment

[pseudoreality]

I may do this in a couple of years when I upgrade if I can't sell my house the traditional route. The idea is to let someone 'buy' a house before they can afford it. They put down a smaller down payment, pay for maintenance, and the owner helps them build up a full down payment with a rent premium. There's risk for both parties.

[Travis Munroe]

I agree on it being a form of predatory lending - you actually hope the buyer defaults if you are the owner of the property as it allows you to send the tenant/potential buyer packing while keeping their deposits (if the contract is structured in said way which they often are)

[Regorium]

I just started with some tenants on this type of contract on one of my properties, and I truly believe it's predatory lending.

The returns are sky high (for now), and frankly, there is no situation where the tenant will win.

Either they can't afford it and we keep their deposits, or they buy the house at a price that we had deemed to be acceptable (ie. guaranteed profits). I've been told only a very very small portion of these rent-to-own contracts actually go through, and it's no big jump to see why. The type of people that can't get traditional financing aren't suddenly going to shape up in 3 years and have enough money for that massive downpayment.

After this one as a learning experience, I don't think I can keep doing this type of thing with good conscience.

[ken0042]

Originally Posted by Regorium

The returns are sky high (for now), and frankly, there is no situation where the tenant will win.

Isn't the sale price pre-determined? In that case, if the market goes up, the tenant wins. If the agreed upon price is $400k, and then after 3 years the house is worth $500k, they would be ahead.

However I do agree that in many cases it is a form of predatory financing.

[Frequitude]

Originally Posted by pseudoreality

I may do this in a couple of years when I upgrade if I can't sell my house the traditional route. The idea is to let someone 'buy' a house before they can afford it. They put down a smaller down payment, pay for maintenance, and the owner helps them build up a full down payment with a rent premium. There's risk for both parties.

These are the exact conditions that lead to predatory lending. If they can't afford it, they shouldn't buy it.

That's why its really only an alternative when the buyer can't get traditional financing (or for some reason gets talked into it without researching traditional financing).

[Frequitude]

I mean, in theory if the terms were zero down and 100% of rent goes to principal then of course you would take it. It's all upside. If prices go up, you're ahead. If prices stay flat, you might still go ahead because you've built up a bunch of principal so are probably above water. If prices go down you walk away for free and its just like you were renting anyways.

Of course, no seller would agree to that. So that means there is a theoretical set of terms in the middle that make the deal "fair". The problem is though that it is very unlikely for you to get the seller to that point. If its fair, they'd rather just wait for a normal buyer to come along with bank financing and get all their cash at once.

[Deegee]

Have been able to finance one rent to own deal in the last several years.

Typically speaking the borrower will still be a high ratio borrower when the term is up and it is time to purchase, and mortgage insurance providers will look at your rental portion and scrutinize it to see if they agree with the parties what portion went towards the down payment.

For example, you rent-to-own a 2 bedroom condo for $1,200 a month and state $500 is going towards the down payment and $700 is rent. Mortgage insurance providers will not recognize the $500 towards the down payment if market price for rent is $1,200.

You also can't make an agreement up at the end of the term, you need to have one executed the day the rent-to-own starts.

Originally Posted by ken0042

Isn't the sale price pre-determined? In that case, if the market goes up, the tenant wins. If the agreed upon price is $400k, and then after 3 years the house is worth $500k, they would be ahead.

However I do agree that in many cases it is a form of predatory financing.

Alternatively, if the market drops, then the buyer likely won't find financing because the loan to values won't jive with the updated property value and the deal will likely be dead for the purchaser even if the agreement was rock solid.

[Regorium]

Originally Posted by ken0042

Isn't the sale price pre-determined? In that case, if the market goes up, the tenant wins. If the agreed upon price is $400k, and then after 3 years the house is worth $500k, they would be ahead.

However I do agree that in many cases it is a form of predatory financing.

You're right. It'd have to be an absolutely huge boom for that to occur. The fixed sale price is very generous towards us, factoring in an average appreciation rate of 4.6% per year over 3 years.

I would consider that to be the win-win situation, and would be ecstatic if that actually occurred.

[calgarygeologist]

A big concern I would have as a seller/owner in a rent to own deal would be property damage if the buyer/tenant doesn't go through with the deal. My understanding of these deals is that the buyer/tenant is supposed to assume responsibility and cost associated with upkeep and repairs during the term. 3 years of poor upkeep or lack of repairs could do significant damage to a home.

[bizaro86]

Originally Posted by calgarygeologist

A big concern I would have as a seller/owner in a rent to own deal would be property damage if the buyer/tenant doesn't go through with the deal. My understanding of these deals is that the buyer/tenant is supposed to assume responsibility and cost associated with upkeep and repairs during the term. 3 years of poor upkeep or lack of repairs could do significant damage to a home.

The counter argument is that a regular tenant can do significant damage to your place while they're renting it, but on a rent-to-own you have a much bigger deposit that protects you.

I've never done one personally, maybe I will some day, especially if I have an existing good tenant who wanted to buy their place over a couple of years.