Homeownership is increasingly becoming out of reach for many Australians, due to growing living costs and rising housing prices.
Many aspiring homeowners are looking for alternatives to the near-impossible task of saving for a deposit, and rent-to-own plans are high on their list of options. To help you decide if this strategy is for you, let’s take a look at what it entails, along with some pros and cons.
What Is Rent-To-Own?
Rent-to-own (also known as rent-to-buy) agreements give tenants the option to buy a home at the end of a pre-determined renting period (usually two to five years), for an agreed-upon sum. It allows would-be home buyers to move into a house right away, with several years to work on improving their credit scores or saving for a down payment before trying to get a mortgage.
Furthermore, committing to a future price protects the buyer against increases in property values, potentially allowing them to get a better deal on the home. However, if the market falls out of favour during the renting period, this can work against the buyer.
While rent-to-own schemes often sound appealing to those trying to buy into the property market, the terms and conditions may not suit all potential buyers. It’s essential to consult an expert who can clarify the contract and your rights before signing anything.
Important: Lease-Option Contracts Vs. Lease-Purchase Contracts
There are two types of rent-to-own contracts. You can choose the one that you think works the best for you. In a lease-option contract, when your lease expires, you have the choice to purchase the home or walk away without having to buy. With a lease-purchase contract, you are responsible for buying the property and cannot back out of the deal.
How Much Does A Rent-To-Own Home Cost?
Rent-to-own schemes have two components: a standard rental agreement and an agreement to buy (which can be optional). Homeowners who want to buy a house through a rent-to-own scheme sign a contract with a seller that allows them to buy the house after the renting period.
Participants pay rent (typically higher than the market average) and a monthly charge for the right to buy the property at the end of the contract. Some rent-to-buy contracts also include other costs for the buyer, such as building maintenance, stamp duty and insurance.
The amount of money paid for the right to buy – which often goes into the tens of thousands – is then usually subtracted from the final sale price. Sometimes, a buyer can arrange to have a portion of the total rent payments deducted from the sale price as well.
Example: Let’s say you sign a three-year rent-to-own deal with a $600,000 agreed future price and a deposit of $30,000 from your savings plus $20,000 from a First Home Owners Grant.
In this case, the landlord may decide to charge you $450 a week in rent (above the average for the area), plus $100 per week for the option to buy the property at the end of the three-year lease. With a year lasting 52 weeks, this means you’ll shell out $85,800 during the first three years, including $70,200 in rent and $15,600 in option payments.
$450*52*3 = $70,200
$100*52*3 = $15,600
$70,200+$15,600 = $85,800
If the contract indicates that the option payments go toward equity in the house (which is not a given) but none of the rent, you’ll need a $534,400 home loan to buy the house at the end of the three-year lease ($600,000 less the $50,000 deposit and $15,600 equity).
$600,000 – ($50,000+$15,600) = $600,000 – ($65,600) = $534,400
Once you reach the end of the lease part of the contract, getting a home loan to buy the property works the same as with any other home loan. Before deciding whether or not to approve your application, the bank will check your eligibility against its lending requirements. If you receive approval, the property’s title should be transferred to your name as the legal owner once the settlement is finalised. You will then need to make regular repayments until the loan is paid off.
Use our mortgage calculators to get a good sense of what to expect from your bank or lender when you rent to buy. If you want to clear up any doubts, call us on 1300 889 743 and we will connect you to our expert brokers.
Rent-To-Buy: Risks And Benefits
It’s worth weighing up an important question: Will you be able to afford the higher-than-average rent, option-to-buy fees, and any other additional costs associated with an RTB scheme, such as insurance and maintenance?
Always seek independent legal or financial counsel before signing any RTB contract, especially considering the potential risks and high costs associated with these schemes.
Here’s what the advantages and disadvantages look like:
- Through an RTB scheme, you can potentially get a foot on the property ladder by renting a property you would like to buy eventually.
- You can delay the need to secure finance until the end of the rental period.
- Meanwhile, you can work on improving your credit and saving money for a down payment while locking in the house you want.
- You get to create some equity if the option money and/or a percentage of the rent go toward the purchase price.
- If the landlord uses the property as security for their debts and defaults on their loan repayments, the security holders may seize the property.
- You don’t own any part of the house until the final rental payment is made and you purchase the home.
When the time comes to buy the property at the end of the rental agreement, you will still need to qualify for a home loan.
- You aren’t on the title, so if you can’t make a payment, you risk losing any equity you’ve built up, as well as the contract.
- You might end up paying an inflated price for the property.
- Even if you make all of your rental payments, you may still be unable to acquire a home loan, and you would lose not only the property but also all of the money you’ve paid.
What Steps Should You Take When You’re Considering A Rent-To-Own Property?
If you’re convinced rent-to-own is the right option for you, you’ll need to take extra precautions to protect your interests. Here’s a rundown of how the rent-to-own process works.
- Once you’ve located a decent home, you’ll need to investigate more to see if it’s a good investment.
- Start the process by doing a pest and building inspection and then consider hiring a licensed valuer to complete a full valuation.
- Ask the seller why they opted for a rent-to-buy scheme, and request documentation confirming their financial security.
- To avoid losing money, make sure you get independent legal and financial advice before signing a rent-to-own agreement.
- Request the assistance of an independent solicitor in drafting a contract, and make sure to include a clause specifying how much of your rent will go toward developing equity in the home.
- A guarantor home loan can help you borrow between 100% and 110% of a property’s purchase price. Instead of a deposit, you use your parents’ (guarantors’) property as additional collateral.
- A low-deposit home loan can allow you to borrow even if you have just a 3% down payment. This can assist you if you are having trouble saving a 20% deposit.
- A low-doc home loan is a mortgage for the self-employed, freelancers, casual employees, contract workers, or anyone who doesn’t fit the usual loan application criteria. This allows them to borrow with fewer or alternative documents. With one of our lenders, you can borrow up to 90% of the property’s worth this way.
- A bad credit home loan allows you to qualify even if you have a bad mark on your credit file or an extremely low credit score. If you have minor paid defaults, you can borrow up to 95% of the property value. If you have greater defaults, judgements, court writs, a part IX agreement, or discharged bankruptcy, you can still borrow up to 90% of the property value.
Make sure you understand the following in the contract:
|Deadlines||What is due and when?|
|Option fee and rent payments||How much of each applies toward the purchase price and home equity?|
|Purchase price||How is the total cost determined?|
|Selection of option contract or purchase contract||Are you required to buy or do you have the option? Does the seller require you to provide advance notice in writing of your intent to buy?|
|Property maintenance||Who is responsible for repairs, maintenance and homeowner association dues?|
|Are the property tax payments up to date and are there no liens on the property?|
|Seller’s credit report||Is the seller financially stable?|
Alternatives To Rent-To-Own
Some people may be interested in rent-to-own schemes if they are unable to obtain a regular house loan from their bank or lending institution due to a low income or a poor credit rating. However, for those in this situation, an RTB scheme is not the only way to jump on the housing ladder.
Buyers who are unable to secure a traditional mortgage have a variety of options, including guarantor loans, low-deposit loans, low-documentation (low-doc) loans, and bad credit home loans.
As an extra option, if you wait a few years, you can save up for a deposit and get a more traditional home loan.
Let The Experts Help Decide What’s Best For You!
We have experts who can help you find a suitable option when it comes to buying a property. If you’re undecided about a rent-to-own home or want to seek an alternative, we can assess your situation!
If you’d like to learn more about how we may assist you with your home loan, give us a call at 1300 889 743 or complete our free assessment form. Our mortgage brokers will assist you in obtaining the best possible rates!