All rent-to-own agreements share a common thread: the buyer will take possession and make payments to the seller over time, and only upon full payment will the seller transfer legal title of the property.
There are generally two ways to structure a rent-to-own agreement; (i) agreement of sale and (ii) rental agreement with option to purchase.
Agreement of Sale
In this type of agreement, the purchase price includes blended payments of principal and interest. The buyer has possession of the property during this time, but no title is conveyed until the purchase price and interest is paid in full.
In these types of situation, the buyer will benefit from building equity in the property so long as they do not default on their payments. The seller benefits since the agreement is a purchase contract and as such, the buyer is obligated to make the purchase or risk being subject to damages. Additionally, the property remains in the sellers’ name until the entire purchase price is paid.
An alternative type of agreement is that that market value rent payments are paid until a set purchase date. The drawback to this type of agreement is the money paid by the buyer isn’t going towards the purchase price and there is no extra incentive for the buyer as only rental payments can be retained in the event of a default.
Rental Agreement with Option to Purchase
In this type of agreement, the person takes possession of the property as a tenant and makes rent payments until they exercise their option to purchase. At this point, the tenant becomes the buyer. The option to purchase in these cases is usually activated within a specified period of time and at a specified price. This arrangement may include monthly rental payments where a portion of the payment (usually above market value) is set aside by the seller towards the purchase price.
Unlike the agreement of sale described above, equity is not built in these situations. If the renter defaults, the agreement usually states that the option to purchase is lost, alongside any deposit and monthly contributions. This makes it easier for the seller to retake possession without having to reimburse the purchaser for payments. However, if the buyer does not vacate the property easily, the seller will have to rely on residential tenancy procedures to remedy the situation.
This type of agreement can benefit a seller who is having difficulty selling their property as it provides an alternative to lowering the home’s price, taking the property off the market, or a longer term rental situation. Additionally, the seller obtains income during the rental period which can assist in paying the mortgage, property taxes, and insurance. Since the sale price is locked in upon signing the agreement, the seller knows what price to expect and that it will not be affected by market declines during the rental period. If the market does decline, especially in cases where there is an option fee or a monthly credit amount, the tenant will still likely be interested in buying the property to avoid losing the funds already put towards the purchase. In the event the property is not purchased by the tenant, all rental payments typically remain with the seller. Additionally, this creates incentive for the buyer to take care of the property as they have a greater vested interest than a traditional rental agreement. Overall, this type of agreement has the potential for the seller to make a good return on their investment.
This arrangement also benefits a buyer who doesn’t yet have enough for a down payment on a home or sufficient monthly income to qualify for a mortgage. The result of a rental agreement with option to purchase is an accelerated path to homeownership with the down payment being spread out over time. Additionally, depending on the agreement, the tenant could take advantage of not being required to pay property taxes or insurance during the rental period. Furthermore, should the housing market increase during the rental period, the buyer benefits from having previously locked in the purchase price. The buyer has no obligation to purchase the home in the end. If they don’t, the buyer would only lose the money already paid towards the house through a fee or a monthly credit amount. If their financial situation becomes more favourable prior to the expiry of the option period, they can proceed with completing the purchase at an earlier date.
While rent-to-own agreements can have potential pitfalls, they can also be a win-win situation between a trustworthy seller and a prudent, financially responsible buyer. Before entering into this type of agreement it is important to ensure that all parties are aware of their rights, risks, obligations, and the appropriate clauses and terms that should be included within these types of contracts. For more information or questions about rent-to-own agreements, please contact one of our lawyers.