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?
Hi Paul,
I’ve been going to many seminars over the past couple years on real estate and wealth creation. I have recently decided to take action into my own hands because I am busting my butt and not getting ahead. I have recently teamed up with a couple of real estate individuals to start a partnership into rent to own on Vancouver Island. I am wanting to get a better understanding from someone who has already experienced what I want to set out and accomplish, that is why I am emailing you. Are you going to be having any other seminars soon, and what advice can you give me, as to be in contact with you and learn from you?
Regards,
Shane
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
1. How does the seller handle the down payment at the end of the term if the sale is going to proceed? Will he have to give a cheque to the tenant/buyer for the accumulated amount, or does he reduce the price of the house? I’m not sure how this part of the deal works.
2. If the tenant/buyer decides not to proceed at the end of the term, does the seller keep the option money as well as the initial deposit?
Thanks for all your advice. I loved your book!
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?
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?
Jackie,
The seller does not write a cheque back to the tenant/buyer when they eventually buy the home. It is shown as a credit. The tenant/buyer can use the credit towards down payment, closing costs or to reduce the final price.
Typically they use it as a credit on their down payment.
If the tenant/buyer does not excercise – then “yes” they forfeit any option deposit to the seller for tieing up their property.
All the best,
Paul M Hecht
Michelle,
The rent-to-own itself does not re-build their credit. The fact that the rent-to-own is typically completed over a 24 – 36 month timeframe, allows time for the tenant/buyer to rebuild their credit with the credit bureaus.
The interest rate, type of loan, etc are dependant on the presonal situation of the tenant/buyer. For example, are they self employes, an employee, is their credit score 500 or 680, do they have other car loans, have they had judgements, etc, etc.
Michelle,
The rent-to-own itself does not re-build their credit. The fact that the rent-to-own is typically completed over a 24 – 36 month timeframe allows time for the tenant/buyer to rebuild their credit with the credit bureaus.
The interest rate, type of loan, etc are dependant on the personal situation of the tenant/buyer. For example, are they self employed, a T4 employee, is their credit score 500 or 680, do they have car loans, have they had judgements, do they have co-signer, what is their income amount and how long have they ben employed, etc, etc, etc.
The best way is for the tenant/buyer to get pre-qualifed with a mortgage broker BEFORE entering into an RTO. The mortgage broker will then give a “likelyhood” that the person will be able to get a mortgage in 24 or 36 months.
Foe example, we worked with a tenant/buyer recently who could get a mortgage on their own today, but lacked enough downpayment. We’ve also worked with tenant/buyers who had 10% down yet needed a higher credit score.
Hope that helps,
All the best,
Paul M. Hecht
Long story short. Was doing quite well in Stoon with property, however I had to give that to an ex wife, so trying to get going again. Have a rental and a rent to own on the go, and my own residence, but now deposits are the problem. However, I go to all seminars that I can, yours, Darren Weeks etc, but your info is always the best.I find the others are just salesmen for their own products.
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