Rent To Buy, or Rent To Own, is a popular strategy to buy a house without needing a bank loan to begin.
It’s a kind of “Lay By” for houses!
Let look at how normal Lay By works:
When you buy something from a retailer on Lay By, you pay a deposit to the retailer to hold the item for you, until you have enough money to buy it.
The retailer effectively takes the item off the shelf, and puts it aside, so no one else can buy it.
Then when you are ready, usually within a specified time period, you can come in and pay the balance if you still want the item.
If you don’t want the item, you are not obliged to buy it, but will probably have to forfeit the deposit you paid in the beginning. The retailer would then return the item to shelf for resale.
Rent To Buy is essentially a Lay By, but with a few additional terms.
If you don’t have enough deposit for a mortgage, or your credit file is not sparkling clean, Rent To Buy may be a way for you to get into owning your own without first getting a bank loan.
When you Rent To Buy, you will pay the vendor (seller) a deposit, known as an “Option Fee”, for the right to buy their house at a price that is fixed from the beginning. Normally the deposit is nowhere near what the banks require for a home loan, so its much easier to start owning your new home.
You now have the right to purchase the house within a certain time period, usually 3-5 years. The price you pay is the agreed price at the beginning, regardless of how much value is added (or lost) on the house. You are now a “Tenant Buyer and the seller cannot sell the house to anyone else during this time.
During this time you pay rent to the owner at normal market rental rates. But you also pay an ongoing option fee to maintain your agreement. Depending on your agreement with the owner, a portion of this will be credited towards the purchase price. So the longer you keep paying the ongoing fee, the less you need to pay at the end.
The total amount you pay each week is close to the amount you would be paying if you were paying a mortgage. Depending on how the agreement is set up, this may include provisions for outgoings such as rates and insurance, which you would ordinarily be responsible for when buying a house.So you need to be able to afford these repayments for the seller to even consider you as a potential “Tenant Buyer”.
But this is great, because it helps you build equity in the house,or a deposit for a bank loan, and may be considered by certain lenders as eligible savings history. Usually, you can also add value to the house by renovation or improving, giving you even more equity!
Claiming your “Lay By”
At any time before the agreed period is up, you can choose to buy the house or not. If you choose to buy it, you will need to pay out the remaining amount to the seller . To do this you most likely will need a bank loan.This is called “exercising your option”.
The purchase will include all the normal steps required in a property transaction, for example stamp duty is payable and title transfers.
So to be sure this will be possible, it will be your goal and responsibility to ensure that you will be eligible for a loan by this time. So during the Rent To Buy period you will need to have sufficient and secure income, minimize your debt and credit card limits, cleaned up your credit file and a maintained history of savings by paying the fees on time, every time. It is wise to talk to a mortgage broker at least 6 months before this time to ensure you are on the right track.
You may choose not to buy the house, but just like with Lay By, you could lose the deposit you have paid and possibly the on going fees. So you will need to be prepared to walk away, unless you can come to an agreement with the seller.
If you are not able to buy, for instance you have lost your job due to injury and the bank will not grant you a loan, you usually have the right to transfer the right to buy it to another person. In other words you can sell it to pay the owners out, and even make a profit if you are lucky!
There are risks with Rent To Buy.
But as with any significant purchase, you should do your due diligence and be sure to get independent legal advice from a lawyer that understands Vendor Finance and has experience with Rent To Buy, or Lease Options.
A bank would not be happy if you did not make the required repayment to a mortgage, and you could lose your house to the bank if you don’t pay. The same can happen in a Rent To Buy.
It is wise to ensure that you:
- Are totally committed to buying a house
- Can afford the payments now, and in the future
- Do what is required to be able to pay the balance at the end of the Rent To Buy period.
Laws vary from state to state, so be sure to find out what is allowed in your area from your lawyer.