How a Rent-To-Own Works
As Rent-To-Owns gain popularity in this type of market, I posted an article written by my mortgage broker on the basics.
After attending my Live 3 Day Training last year and learning the in’s and out’s of how they really work; Scott’s business has grown from his better understanding and insight on what investors are trying to achieve.
This understand help him explain it to his underwriters and get your deal approved.
Here’s Scott Peckford’s (Mortgage Architects) article re-posted on my blog.
A Rent-To-Own is very similar to a car lease.
With a car lease you put down a deposit and make payments for a specified period of time at the end of the lease you have the option (not the obligation) to purchase the car for a predetermined price.
A rent to own works in much the same way. A buyer puts down a deposit, usually much less than the traditional 5% and makes a monthly payment. A portion of the rent is a credit towards the future down payment.
Here’s An Example:
Bob cannot get a mortgage because of a low credit score and a small down payment. He has reliable income and a plan to build his credit over the next 24 months.
He decides to do a rent to own with the following details.
Purchase Price $350,000
Initial Deposit $5,500
Monthly Payments $2000 (Rent $1500 Credit $500)
Term 24 months
Repairs and maintenance – Any repairs under $500 Bob pays for himself.
At the end of the 24 months Bob will have a full 5% down. ($500 x 24 = $12,000 + $5,500 = $17,500)
The important point in Bob’s case is he needs a plan to build his credit.
If a potential buyer is not able to qualify for a mortgage today it is important to determine what steps need to be taken in order to be in the best possible position in the future.
What Are The Benefits to the Seller?
The seller is able to have someone pay higher than market rents and take care of any minor repairs and maintenance.
In today’s rental market rent doesn’t always cover the monthly expenses.
Also, since the deposit is generally non-refundable when a tenant puts down a money for a rent to own scenario they tend to be really good tenants.
Why Would a Renter Do This?
It allows them the benefit of homeownership without having to qualify at a traditional bank right away.
It also works as a forced savings plan. Since a portion of the rent is going to be used as a credit for the down payment every month that passes the buyer’s down payment increases.
What Makes Someone A Decent Rent to Own Candidate?
- Low or No Credit – Credit is certainly one. If a potential buyer has been turned down by a bank because of credit problems an RTO can work for them. However, it is important for the buyer to have a realistic plan to get their credit back on track. (We have a program designed specifically for this.)
- New to Canada – Another situation where an RTO can be useful when a buyer is new to Canada. Often when new immigrants come to Canada qualifying for a mortgage can be difficult. A RTO allows the new Canadian to get a foot on the property ladder earlier than would otherwise be possible.
- Newly Self-Employed – Buyers who have been self-employed for less than 2 years will find it difficult to qualify for a mortgage at a typical bank. Since most lenders require a history on your self-employment income an RTO can give the self-employed buyer a chance to get their business going while still working towards homeownership.
What Are the Risks for the Buyer?
If the buyer is unable to qualify for a mortgage at the end of the term they risk losing their deposit monies.
The biggest mistake buyers make is not having a realistic plan before entering into an RTO.
Speaking with an experienced mortgage broker or banker and developing a plan will help reduce but not entirely eliminate this risk.
What Are The Risks for the Seller?
The biggest risk is the buyer will not, or cannot buy your home at the end of the term. If this happens the seller would have to attempt to sell the home again or do another RTO.
If you have any questions about financing your Rent to Owns or need help with that hard to finance deal, give Scott Peckford a call at 250-762-7526, Mortgage Architects.
If you want to learn more about Investing with Rent-To-Own, simply attend my upcoming Live Training »
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Comments
Paul
Will you ever be in Southern Ontario for any live training? Would love to attend but cannot make BC for Oct 25th because of work committments.
Hello,
How does a RTO work in the sense of rebuilding credit for a renter? What kind of loan would they be able to qualifly for? How are they able to know if they will be approved once the term is up?
Mike,
An RTO give the tenant time to rebuild their credit and shows the eventual lender a steady history of payments.
At the end of the term, the tenant/buyer will be applying for financing based on the personal credit, income and downpayment near the end of the RTO agreement.
A tenant has no guarantees that they will be able to qualify for a mortgage when the term is up. However, in all our Rent-To-Owns we send the tenant/buyer to a good mortgage broker before entering into an RTO. The broker assess how and when the tenant/buyer will be able to qualify for a mortgage. The broker will give them a plan as well as personal credit repair advice and as long as the tenant/buyer sticks to the plan – then the success rate is very high.
All the best,
Paul M. Hecht
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