How a Rent-To-Own Home Works

A rent-to-own arrangement can be an alternative path to home ownership if you’re unable to qualify for a traditional mortgage. .

Rent-to-own isn’t a common method for buying a home, generally because it can be complex and risky. It’s crucial to understand how rent-to-own works before deciding if it’s right for you.

» MORE: Should you rent or buy?

What is a rent-to-own home agreement?

A rent-to-own agreement (sometimes called a lease-to-own agreement) is a contract between you and a landlord or rent-to-own company. In general, you agree to rent a home for a set period, usually one to five years, with the intention of buying it.

Despite the name, renting-to-own does not mean your rent payments give you any ownership rights.

Instead, a portion of the rent paid during the rental period is put aside by the landlord to be used as your down payment when you apply for a mortgage. Rent-to-own tenants often pay above-market rent to generate these rent credits.

Even after saving years’ worth of rent credits, you’ll still have to qualify for a mortgage based on a lender’s borrowing criteria. This might involve contributing additional cash to cover the rest of the down payment.

Depending on the kind of contract you sign, you may have the option to buy the home at the end of the rent-to-own agreements, or you may be obligated to buy the home (and pay a penalty if you don’t).

How does rent-to-own work?

Types of rent-to-own agreements

Lease-option agreement

With a lease-option agreement (also known as an option-to-purchase agreement), you rent the home for a given period and, if your contract stipulates it, some money from your rent may be set aside for a down payment.

You will also be expected to provide a non-refundable deposit (1% to 5% of the property’s asking price) to secure the right to make an offer to buy the home in the future.

At the end of the rent-to-own agreement, you’ll have the option to buy the home but are in no way obligated to do so. However, if you choose not to buy the home, it’s unlikely you’ll be refunded the deposit or the rent money that was set aside for the down payment.

That may not sound fair, but think of it as an opportunity cost. The owner of the home kept it off the market in order to sell it to you. By not moving forward with the purchase, you may have cost them a substantial amount of money.

Rent-purchase agreement

With a rent-purchase agreement, you commit to purchasing the home at the end of your rental agreement. You also provide a deposit and have a portion of your rent money set aside to be put towards payment for the home.

If you renege on your agreement to buy the home at the end of the contract, you’ll forfeit the extra rent money and deposit, and may even pay additional fines, depending on the terms of the agreement.

Are rent-to-own homes a good idea?

Rent-to-own is a risky endeavour with no guarantees intended for people who generally have blemishes on their credit history. Succeeding in a rent-to-own scenario often requires prospective buyers to establish and maintain rigorous financial habits that have so far eluded them. It’s not a realistic outcome for everyone.

Not qualifying for a mortgage may be a signal that you’re not quite financially ready to buy a home. Rather than entering into a rent-to-own agreement, it might be a better idea to shore up your finances while paying rent to a traditional landlord and saving up a down payment using a First Home Savings Account.

Who is rent-to-own best for?

Because of the increased rental costs and risks involved, rent-to-own is generally viewed as a last resort for home buyers who can’t get approved for a mortgage at a traditional lender.

Buyers with low credit scores, no Canadian credit history or blemishes on their credit profiles might all turn to rent-to-own. While entering into a rent-to-own contract doesn’t guarantee that a renter will eventually qualify for the mortgage they need, it provides an opportunity for them to try.

Potential benefits of rent-to-own

Rent-to-own risks

Alternatives to rent-to-own

Rent-to-own is typically an option for people who want a home but can’t yet qualify for a mortgage. If that’s the position you’re in, you may want to first investigate some of Canada’s B lenders, who offer bad credit mortgages.

If you’re new to Canada and a lack of credit history is creating a roadblock, some of Canada’s Big Six banks offer mortgages for newcomers.

Alternatively, you might also consider getting someone in a more stable financial position to co-sign your mortgage.

Provinces with unique rent-to-own rules

Ontario

Ontario law mandates that there must be two separate rent-to-own agreements between renters and their landlord:

Alberta

Rent-to-own agreements in Alberta must adhere to the province’s Rental Tenancies Act. One of these is that the rental option fee/deposit can’t be more than 4.9% of the property’s value. A landlord must also provide written notice of the tenant’s rights and obligations contained in the rent-to-own agreement.

Prince Edward Island

PEI’s provincial government offers a rent-to-own program for home buyers that fit its qualification criteria. Income and home price limits apply.