A perfect storm of rising living costs, “low and slow” wage growth and increasing house prices is rapidly blowing home ownership beyond the reach of many Australians.
Faced with the near impossible task of saving for a deposit, many aspiring home-owners are seeking out alternatives, with rent-to-own schemes high up on their list of choices.
Below, we break down what these schemes are, how they work, and how much they cost.
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Rent-to-own schemes often make it easier for first-home buyers to get onto the property ladder. But they also come with risks. Picture: Getty
What is rent-to-own?
Rent-to-own schemes (also known as rent-to-buy schemes) are leasing agreements that afford renters the right to buy a home at the end of a pre-determined rental period, at a price agreed prior to signing the agreement. They make it easier for aspiring property owners to get onto the property ladder, by eliminating the need to save a traditional deposit and by delaying the need to secure finance from a bank or lending institution.
And, by setting in stone the future sale price, they also shield the buyer from any future house price spikes, which means the buyer could potentially snag the home for a cheaper price. However, this can also work against the buyer, if the market experiences a downturn during the rental period.
The major downside to rent-to-own schemes is that participants don’t own any part of the home until they’ve made the final payment. That, and the fact they still need to apply for a home loan when the time comes for them to buy the property at the end of the rental agreement.
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Rich Harvey, managing director of buyers’ agency Propertybuyer, says the schemes help buyers – usually those unable to secure traditional home loans – to “get into a home” without having to shell out substantial upfront costs. But he doesn’t mince his words when asked about their overall legitimacy.
“I’m not a big fan of them, because too many things can go wrong,” he says.
“You’re not on the title, and so, if you’re unable to make a payment, you can lose whatever equity you have built up. And you also might end up paying an inflated price for the property.”
This means that missing a single rental payment could result in termination of the contract, leaving you out of pocket and without a home.
Renters buying properties under a rent-to-own agreement pay for the option the property, in addition to weekly rent. Picture: realestate.com.au/buy
“Even if you complete the rental payments, you may still not obtain a home loan and lose not only the property, but also all the money you have spent,” a Consumer Affairs Victoria spokesperson adds, before pointing out that the financial situation of the vendor can also impact the buyer.
“If the vendor has a mortgage over the property and fails to keep up with their own repayments, their lender has the right to repossess the property. In this case, the [prospective] buyer would lose all rights to continue making payments towards eventual ownership of the property,” they said.
Some analysts, however, believe that rent-to-own schemes can work for both renter and landlord.
How do rent-to-own schemes work?
Rent-to-own schemes have two components: a standard rental agreement and an option to buy. Aspiring home owners who wish to purchase a property through a rent-to-own scheme sign a contract with a vendor that affords them the right to buy the property at the end of an agreed rental period, which usually runs anywhere from two to five years.
These schemes will normally require a deposit, which aspiring home owners tend to secure by applying for the First Home Owners Grant.
During the rental period, participants pay rent (usually above the market average), as well as an ongoing fee for the ‘option’ to buy the property at the end of the contract. Some rent-to-buy contracts also require the participant to cover additional outgoings such as building maintenance, stamp duty and insurance.
Over the course of the rental period, the total money paid out for this ‘option to buy’ – which often runs into the tens of thousands – is then usually deducted from the final sale price.
How much does it cost?
The costs of rent-to-own schemes can vary wildly. Participants are generally required to pay well above the market rent, as well as an additional ‘option’ to buy the property at the end of the tenancy agreement.
As with all rental prices, however, the exact amount of rent and the exact amount of the option will vary from house to house and suburb to suburb.
Let’s say you enter into a three-year rent-to-own agreement with an agreed future price of $450,000, and pay a $28,000 deposit, $20,000 of which comes from a First Home Owners Grant.
In such a situation, the landlord might decide to charge you $600 rent (well above the average market rent for the area), plus $100 a week for the option to buy the property at the end of the three-year agreement. This would mean you would shell out a $109,200 over the initial three-year period.
Provided the contract states that the ‘option’ goes towards equity in the house (which is not a given), at the end of the three-year lease, you would need to get a $406,400 home loan to make the purchase ($450,000 minus the $28,000 deposit and $15,600 equity).
This would mean that a house valued by the vendor at $450,000 would end up costing you $543,6000 ($450,000 plus $93,6000 rent). And you would also need to take out a $406,4000 home loan to make the purchase.
Under many rent-to-own agreements, missing a single payment means forfeiting your deposit and any ‘equity’ in the home.
How to start the rent-to-own process
There’s no hiding from the fact that rent-to-own schemes come with lots of risks. But if you’re convinced they’re the right option for you, then here’s what you should do next.
Step one: Find a property
Given there are a number of things that can go wrong for both renter and seller, the supply of rent-to-buy properties is fairly limited. Which is why finding a suitable scheme may take longer than a traditional house hunt.
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Step two: Research the home
Once you’ve found a suitable home, you’ll need to dig a little deeper to determine whether it’s a worthwhile investment.
Kickstart the process by ordering a pest and building inspection, and then consider paying a licensed valuer to carry out a detailed valuation.
Step three: Research the seller
This step is important because entering into a rent-to-own agreement effectively ties your future living arrangements to your seller’s financial circumstances. If they default on their mortgage, the bank could repossess the home, leaving you out of pocket and without a place to live.
Ask the seller why they are interested in selling through a rent-to-own agreement, and ask for documents that prove their financial security.
Step four: Seek legal advice
Before entering into a rent-to-own agreement, make sure you seek independent legal and financial advice, so that you don’t end up getting yourself into debt.
Ask an independent solicitor to help draft a contract, and make sure that they include a clause that clearly outlines how much of your additional rent will go towards building equity in the home.
If you’re a tradesperson, consider asking the home owner whether they’d reduce the rent in return for some minor home improvements.
Step five: Keep up with your rental payments
Once you’ve signed on the dotted line, the onus is on you to keep the deal alive. Draw up a budget and stick to it, as missing a payment could see you and your family turfed out on the street.
Step six: Secure a home loan
After the end of the rental period, you’ll need to take out a home loan so that you have enough money to pay for the home.
Check out our mortgage calculator to get a good idea of what to expect from your bank or lender, and then head to a branch to put pen to pater.
Step seven: Buy the home
Congratulations: after years of renting, it’s finally time to buy the home.
The sale price should have been laid out in the initial contract, so the negotiation should be short and sweet. All that’s left is to pop the champagne.
Can I rent-to-own with bad credit?
The short answer is yes. Aspiring home buyers who enter into a rent-to-own agreement do not own any part of the property until they’ve made the final payment, which means that the vendor is not at risk should they default on their payments.
As a result, vendors are far more likely to enter into a rent-to-own agreement with a prospective buyer who has bad credit than a bank is likely to offer them a mortgage.