RENT-TO-OWN: Ensuring your Success
Rent to Own’s can be tricky to complete in the lending space, however; if set up properly this type of contract can lead you down the path towards home ownership.
A rent-to-own contract is essentially a purchase contract with an extended period of time between the acceptance of the contract and the closing date. It is important that the Buyer and Seller each have their own representation…lenders will not allow a Solicitor to represent both the Buyer and the Seller.
As a first step, I would advise contacting a Mortgage Professional prior to entering into a rent-to-own contract. Even though you may not qualify for a mortgage right now (thus the reason for the rent-to-own), you can be given valuable advice and a road map to ensure your success and the completion of the contract at the end of the term.
There are several very important aspects to consider in a Rent-to-Own scenario:
Setting the Purchase Price and Completing the Contract (Offer to Purchase)
In order to determine the purchase price, there must be an appraisal completed up front and kept on file. This appraisal will also need to include market rents for that property. The market rents will determine what you will pay as rent for the property and any amount over and above that will be put in trust towards the purchase (we will discuss this further below).
The contract will need to have an end date agreed upon by both the Seller and the Buyer (1-3 years is typical). For contracts longer than 3 years, it would be advisable to register the rent-to-own as a lease on the title of the property. This can be discussed with your Solicitor in greater detail.
It is very important that the contract states clearly that if the buyer is unable to complete the transaction (i.e., cannot get approved for a mortgage at the end of the contract), then the deposit and funds received over and above market rent are to be refunded (or partially refunded, at the very least). Often, this is left out of many contracts and is one of the reasons that Buyers will see a decline from their lender when it comes time to obtain the mortgage. Any equity built in the property during the Rent to Own period will belong to the Buyers, and it is a good idea to stipulate that point in the contract as well. If an adjustment to the purchase price is agreed upon at the end of the contract, then the Solicitors representing the Buyer and Seller will execute an amendment to the original contract.
The contract must state the rental amount PLUS the amount being paid in addition to that (if any). This needs to be clearly stated and broken out as rent and equity being built – which will ultimately add to the Buyer’s down payment. There also must be a deposit given on the property and the amount of that deposit stated in the contract. Depending upon the size of the initial deposit given, it may be enough to cover the full down payment of the property (minimum of 5% of the purchase price). In this case, the buyer may be only paying market rent until they are able to complete the purchase. In other cases, a smaller deposit was given OR the buyer would like to pay additional funds monthly to build up equity in the home. This built-up equity will be viewed as the down payment, in addition to the initial deposit, at the end of the contract term.
Upon acceptance of the rent-to-own contract, the deposit must be given to the seller and is to be held in trust with their Solicitor. This deposit amount can vary and as mentioned above, can form part or all of the down payment. Much like a traditional purchase contract, any funds that will form the down payment must be held in trust until the completion of the contract. If the rent-to-own has a 3-year term, then all those funds will be held in trust with a Solicitor for the full 3 years.
Managing the Funds
Another common reason for a decline at the end of the rent-to-own term relates to how the funds have been managed. The deposit and any funds received over and above the market rent (as set out in the contract) must be held in trust with a Solicitor. They cannot go directly to the Seller. When the time comes to complete the purchase and obtain a mortgage, the Buyer will be requested to provide a statement of the account from the Solicitor in order for the lender to verify the initial deposit and any other funds that will form the down payment.
Already Have a Rent-to-Own Contract in Place?
Does your rent-to-own contract not fall in line with the guidelines above? First, don’t panic! We do have lending options for you outside of traditional institutions. Most likely, you will need to be placed with a private lender for a short term (1 year, ideally) and then move to a traditional lender after that. Keep in mind that going with a private lender will mean that you will need a minimum of 20-25% of equity in the property. Depending on the type of property and the location, you may be required to have even more. The more rural a property, the more equity will be required. Private lenders are willing to take on more risk and therefore will also have a higher interest rate and initial fees.
Each mortgage file, whether a rent-to-own or a traditional contract is unique. It is best to consult with a mortgage professional who can help you navigate the lending options.