It’s no secret that saving for a down payment can take years for many Canadians, and that’s why many are exploring alternative ways to enter the housing market. In fact, according to a 2024 survey, 22% of Canadians would consider rent-to-own to buy a home. While rent-to-own is becoming more mainstream, it isn’t a common method to buy a home. Before you decide if renting-to-own is right for you, it’s essential to understand how rent-to-own works.
Key Takeaways
- Rent-to-own allows you to lease a home with the option (or obligation) to buy it at a later date
- It typically involves paying higher-than-market rent, a portion of which becomes your future down payment
- It’s best for those who can’t currently qualify for a mortgage, and it is typically considered a last resort option
What is a Rent-to-Own Home Agreement?
A rent-to-own agreement is a lease agreement between a homeowner and a renter who intends to purchase the property at the end of the lease term. The agreement outlines several elements to ensure a clear understanding between the landlord and the renter.
Term
A typical rent-to-own agreement term ranges from one to five years. At the end of the term, the renter will purchase the home from the landlord.
Option Fee
The option fee is a nonrefundable deposit that the tenant makes at the beginning of the lease. The option fee amount varies and is typically a percentage of the purchase price. When you buy the home at the end of the lease term, the option fee is deducted from the home’s price.
Rent Credits
Rent credits are the portion of your monthly rent that goes toward your down payment when you purchase the home. Typically, the monthly rent is higher than market value in a rent-to-own agreement.
The rent-to-own agreement will state how and where the rent credit and option fee funds are held. It’s important to note that no real estate brokerage is involved in a typical rent-to-own transaction. As such, there is no regulatory obligation for the rent credit and option fee funds to be held in a trust account. However, funds in a lawyer’s trust account are subject to the same protections and obligations as a real estate brokerage. They can only be released in certain circumstances, like when the deal closes.
Purchase Price
The final purchase price is predetermined and stated in the lease agreement. Since the price is fixed, it does not change due to market conditions.
Maintenance and Repairs
Maintenance responsibilities should be clearly outlined in the rent-to-own contract. Often, the renter is responsible for most maintenance and repairs since they will eventually own the home.
How Does Rent-to-Own Work?
The first step is to find a home that the owner is willing to rent to own. Then, you will need to work with a real estate lawyer and mortgage professional to complete the contract. The contract will outline the lease period, the rent payments, the final sale price, the rent credit structure, and other conditions. While you are not purchasing the home immediately, getting a home inspection before committing to a rent-to-own agreement is a smart idea.
After that, you can move into the home and live there during the lease period while making your monthly rental payments. During the rental period, you should prepare to apply for a mortgage by paying off debt, improving your credit score, or increasing your income.
At the end of the rental period, you will apply for a mortgage and purchase the home. If you cannot buy the house, you may need to renegotiate the contract or lose the money you’ve contributed, depending on the type of rent-to-own agreement.
Types of Rent-to-Own Agreements
Now that you know how rent-to-own works, it’s important to understand the two types of rent-to-own agreements. The major difference is the amount of commitment and flexibility for the tenant.
Lease-option agreement
A lease-option agreement states that you have the option to purchase the house when the lease ends, but you are not obligated to do so. A lease-option agreement is more flexible and offers you, as the tenant, the chance to walk away at the end of the lease term.
Rent-purchase agreement
By contrast, a rent-purchase agreement states that the tenant is obligated to buy the property at the end of the lease period, and there are penalties for failing to do so. You should be confident in your ability to be approved for a mortgage before entering into a rent-purchase agreement.
Who is Rent-to-Own Best for?
Rent-to-own homes are not without their risks, but they can be a good option for several different types of buyers:
- Those who can’t qualify for a mortgage right now
- Those who don’t currently have a down payment saved
- Newcomers to Canada or those without a credit score
Rent-to-own is typically considered a last resort option since it is not a guarantee that you will be able to qualify for a mortgage at the end of the lease term. Before committing to a rent-to-own agreement, you should explore other mortgage options like B lenders, mortgages for newcomers, and guarantor mortgages.
Benefits of Rent-to-Own
- Path to homeownership for those who haven’t qualified for a traditional mortgage
- Provides time to build your credit score and pay off debt
- The purchase price can be negotiated in advance
- Move into the home right away
Rent-to-Own Risks
- No guarantee you will qualify for a mortgage when the lease expires
- Contracts can be complex
- You may be responsible for home repairs while you are renting, depending on the contract
- You lose the option fee and any equity if you cannot or decide not to buy the property
Province Specific Rent-to-Own Rules
Some provinces have specific rent-to-own rules or government-run rent-to-own programs.
Ontario Rent-to-Own Rules
In Ontario, the law mandates two separate agreements between the renter and the landlord. The first, the lease-option agreement, contains the final purchase price and the number of monthly rent payments. The second, the lease agreement outlines the monthly rent, the expiration date, and other obligations of the renter and landlord.
Alberta Rent-to-Own Rules
Rent-to-own agreements in Alberta must comply with the Residential Tenancies Act (RTA). Specifically, the option fee cannot exceed 4.9% of the property’s value, and the landlord must provide written notice of the tenant’s rights and obligations.
PEI Rent-to-Own
Prince Edward Island is currently offering a Rent-to-Own Pilot Program to Island residents who do not currently own a home. To be eligible for the program, you must have a formal letter confirming you’ve been declined for a mortgage from a recognized financial institution, a satisfactory credit rating, and a household income of under $100,000. Under the pilot program, you will enter a 5-year rent-to-own agreement with Finance PEI.
Is Rent-to-Own For You?
Now that you understand how rent-to-own works, how it differs from a traditional rental agreement, and the pros and cons, you can decide whether rent-to-own properties suit your situation. Remember that when you purchase a rent-to-own home, you will still need to pay closing costs when the lease ends.
Rent-to-Own FAQ
Are rent-to-own homes a good idea?
There are risks associated with rent-to-own homes. For instance, you may not qualify for a mortgage at the end of the rental term. Be sure to consult with a real estate lawyer and mortgage professional before you sign any contracts.
Do you need a down payment for rent-to-own?
You need to pay a deposit, often called an option fee, before moving into a rent-to-own home. Then, the extra rent you pay throughout the lease becomes your down payment. Still, you’ll need to budget for closing costs when purchasing the home.
Does rent-to-own require a good credit score?
While you will eventually need a good credit score to qualify for a mortgage, you can work on building your credit score and credit history during the lease period.
