Rent To Own?

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After my post a couple of days ago, one of my readers had commented how a “rent to own” option may be a more affordable way for somebody as opposed to private financing. So as a result, I thought it would be appropriate to talk a little bit about this subject. I certainly don’t hold myself out as a “rent to own” expert, but I know my way around a little it a bit.

A “rent to own” option is where you enter into an agreement with a property owner who allows you to rent his/her property with the option of buying it within a specific period of time, usually from 12 to 36 months from the date of the agreement. The agreement basically lays out the (future) purchase price, the deposit/down payment you’ll require, how much you’ll pay monthly to the landlord, how much of the monthly payment will be credited to your future purchase price and additional terms that are agreed upon between you and the landlord. So let’s take a look at what this might look like…

(Future) Purchase Price = $250,000.00
Deposit/Down payment = $7,500.00 (To be credited to the purchase price)
Monthly payment = $1,800.00 of which 400.00 will be credited to the purchase price.
Term = 24 months.

So what this simply means is the tenant will purchase this property in 24 months for the purchase price of $250,000.00 and $17,100 will be credited towards the purchase price which is made up of the deposit of $7,500 + $9,600.00(which is the $400 extra rent X 24). This would leave the tenant to finance the difference of $232,900. + CMHC/Genworth fees. 

Okay, so in theory I guess this looks good but here are a few things to consider…
1) The deposit in most of these deals is held by the landlord. How can you be sure that it’s safe and will be applied to your deal? Because he’s a nice guy? Well maybe he is but what if he gets in trouble financially. He could potentially not only lose your down payment, he could even lose the house to the bank! Then where does your deal stand? It dead!!
2) Why are the monthly payments so high? That’s because the only money that can actually be credited towards the purchase price is only monies that are paid in excess of what is deemed to be “market rent”. So in other words you could rent this same type of house for $1,400./mth. NO part of the market rent can be credited to you.
3) The purchase price of $250,000. Remember, you’re not buying that house for 24 months so what is that house worth today? NOT $250,000. The landlord has padded that price substantially, usually very heavily in his favour. What if at the end of the term the house doesn’t appraise for the $250,000 you agreed to pay? Well that’s your tough luck. You either find the money somewhere else or you lose the deal and all your money.
4) What if at the end of the term you decide you don’t want to proceed or can’t proceed because of a job loss or credit issues. What happens to the deposit and excess rent? IT GOES INTO THE LANDLORDS POCKET, the deal dies and he looks for another sucker!

So if these things can get so ugly, why are they so popular? Well you have to remember the market has been going up for so long that it was almost impossible for these deals not to work. If fact in most cases, they were win/win because the house value more often than not went up more than the agreed upon price in the RTO agreement. So that meant you were buying the house under market value and the landlord was still making a profit. But the market isn’t what it used to be and nobody knows for sure which way it’s going to go. And don’t forget, with the house values being so high, investors had to find a way to create positive cash flow because the monthly rent wasn’t enough to carry their expenses.

Listen, if I was a first time buyer today and I couldn’t buy a property right away because of credit, here’s what I would do.

1) Look for alternative financing. By that I mean a non conforming lender that’s willing to take a chance or private financing. But if the numbers don’t make sense, DON’T BUY NOW! WAIT!
2) Rent a house. That same house you can “rent to own” for 1800/month can actually be rented for 1300 or 1400 a month.  So you’re going to save $400 a month.
3) Take that deposit you were going to give the landlord and contribute it to your RRSP. But don’t put it in a stock or mutual fund that is subject to market corrections. Just put it in a GIC or money market fund. Keep it safe!  As a first time buyer you can use it purchase your property when you’re ready.
4) After you’ve opened the RRSP, arrange to have that $400 extra automatically deposited into your RRSP. At the end of this you’ll have that same $17,100 but it will be in your pocket not in the hands of somebody that might take it away!
5) Now that you made that nice RRSP contribution, you are now eligible for a nice tax refund to, which you can use to pay down your mortgage.

I think “rent to own” agreements have their place but they have to be properly drafted to protect all parties, not just the landlord.

Make it a great day!

Walter Monteiro.

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