Here’s how it works:
The landlord rents the home or condo with the standard rental contract. For an extra payment, the tenant receives an option to buy the home at a later date, for a set price. Let’s say the home is worth $250,000. The parties agree the tenant will have the right, but not the obligation, to buy the house in three years for $280,000.
The fee for this right, or option, is usually 2 or 2 ½ per cent of the final price. In this example, 2 percent of $280,000 would be $5,600. Then, each month, the tenant pays an extra fee, say $200, that also is applied to this option price. At the end of the three-year lease term, the tenant has put up close to 5% towards the purchase price option. In this example, it would be close to $13,000.
If the tenant exercises their right to buy, they can use the $13,000 as the down payment and apply for a mortgage to finance the rest of the purchase.
The advantages for the tenant:
•You may not have the down payment now, but you will have it at the end of your lease, as a result of the additional payments;
•If your credit is not good, you can improve it by making timely payments of rent;
•You can try out the neighbourhood and if you change your mind later, you can just cancel the option;
•If the market price of this home is more than $280,000 at the end of your lease, you still get to buy it for the same $280,000.
•If the market collapses and the home is worth less than $280,000, you do not have to go through with your purchase.
Some disadvantages of Rent to Own:
•There is no guarantee that a bank will give you your financing when you exercise your option. You still have to improve your credit score or find someone to co-sign your application;
•If you don’t go ahead with your purchase, you usually have to forfeit the option payment.
Some advantages for the landlord:
•Tenants on rent-to-own typically take better care of the property, thinking that they may own it one day;
•Your profit is fixed at the time of the option.
As a Realtor, I think homebuyers can do better. The best way to buy a house is to establish credit and have the down payment ready. After that, everything else is just a gimmick and a scam.
If you have any questions or comments, please email me.
You may also be interested in my 365 Rules about Real Estate
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Source: The pros and cons of rent to own