Entering a rent-to-own contract can seem like a great way to acquire a home, especially for those who want to live in a specific property or location, but don’t quite have the cash for a full down payment for traditional financing. The buyer gets to live in the residence, put money towards the down payment every month, and eventually purchase the rental they are living in.
Rent-to-own agreements contain specific terms regarding the purchase price, the amount of rent, how much of that rent is applied to the down payment, and the date by which the buyer must complete the purchase of the home. These agreements generally also state that, should the buyer fail to complete the purchase as scheduled, the amount the buyer has paid towards the down payment is forfeited to the owner of the property. Such terms are designed to provide certainty to the owner, that the buyer will take the necessary steps to complete the transaction. But they also contain a lot of risks for the buyer.
As an example, let’s say Bob has signed a contract on May 1st, 2020, which indicates that he must complete the purchase of the property by May 1st, 2023, for $500,000.00, or lose his down payment. On May 1st, 2020, Bob qualified for a $480,000.00 mortgage, so he thought he was secure. Over the course of the 3 years of renting, Bob has paid $20,000.00 in rent which was earmarked as down payment and owes $480,000.00 towards the purchase price. Unfortunately, during the same 3-year period the market value of the property has gone down from $500,000.00 to $400,000.00. Because the market value has decreased, Bob’s bank will only give him a mortgage for up to $380,000.00. Therefore, Bob must either come up with the remaining $100,000.00 owing on the purchase price himself or lose his $20,000.00 down payment. Even if he does come up with the extra money, suddenly Bob is stuck owning a property which is worth way less than he paid for it. Even if the value of the property stayed the same or increased, other things could have happened during that three-year period, including:
- Bob could have lost his job.
- Bob could have been forced to take a pay cut; or
- Interest rates could have increased.
All these scenarios could mean Bob would not qualify for his mortgage and potentially be unable to complete the purchase, therefore losing his down payment. Bob could also be evicted from the property if the owner decided to give notice to vacate the property and not continue with a rental scenario and look to put in another rent-to-own prospect. In all these situations, it’s a lose-lose situation for Bob. Bob would have been better off to simply rent a different property, save up his down payment funds himself, and look for a property when he was ready.
One misconception regarding rent-to-own arrangements is that the owner is taking a haircut on the rental income by applying a portion of the rent towards the down payment. While this may be true in some scenarios, in our experience the owner does not ever really lose and simply charges the buyer higher than market rent for the property. So, while market rent may be $2,000.00 per month, the owner could charge poor Bob $2,500.00 per month, and do him the “favour” of applying $500.00 each month towards the down payment. So again, Bob could simply rent another property at the same market rent of $2,000.00 per month, put $500.00 a month away in their savings or investments, and come out with a down payment ready to go, without the risk of losing it if he cannot complete the purchase. While less risky, this more conservative approach is likely to mean that Bob will not have the opportunity to purchase the property he desires now.
Obviously, there is a lot to consider before entering into a rent-to-own. It is always recommended to speak with your lawyer to discuss the terms of the agreement and understanding the risks and consequences of the agreement. If you are looking to speak with an industry professional about this topic further, please contact Rees or Kari with the Smith & Griffith Real Estate Team with CIR Realty to advise you through the process!
The twelfth instalment of our series with Dan Hawkwood, an Associate Lawyer at Beaumont Church LLP in Calgary. Dan comes from a long line of farmers and ranchers in the Calgary area and brings the experience of his rural upbringing to his practice.
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