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RENT TO OWN (RTO) EXPLAINED — How Rent To Own (RTO) Work In Canada
One real estate strategy that is generally overlooked is rent to own or lease option homes. What is a rent to own home? It’s pretty much exactly as it sounds. It’s where an investor, or home owner, rents out their property to a tenant, but gives the tenant the “option” to purchase the home after a specified period of time at a predetermined price.
Home owners sometime use this strategy as an incentive to get their home sold, even if it means taking payments for a certain period of time. Home buyers with poor credit, and low amount of savings for down payment, may find this method of financing very attractive. It enables them to get into a home right away, while building their credit and down payment through rent credits over time.
For the investor, selling a house via rent to own or lease option is very similar to selling a covered call. The tenant has to pay the investor an upfront “premium” for the option to purchase the house, this is called the “option deposit”. At the expiry, which is negotiated between the investor and tenant, the tenant has the option of purchasing the house at a predetermined price. The option deposit, along with any rent credits, are used as part of the down payment on the house.
How does rent to own work?
The house is listed as a rent to own with monthly rent at the high end of rentals in the area, and a small option deposit (2.5% of the property value). The option deposit goes towards the purchase of the home and is non-refundable.
Tenants are screened for credit, employment and potential for purchasing home at end of the term. Some tenants are asked to commit to a credit repair program offered by a credit professional.
Tenant moves in, landlord collects rent and option deposit upfront. A separate lease and purchase agreement is signed.
A small portion of the rent, called a rent credit, is put against the purchase price of the home. The rent credit is at the discretion of the investor.
If the tenant decides not to buy, the tenant loses their option deposit and rent credits. If the tenant can not close, due to credit or lack of income (job loss, or job change, etc) only a very small portion of the deposit and rent credits is refunded.
- Rents are typically higher;
- Option deposit collected upfront;
- Tenant is responsible for maintenance and repairs;
- Tenant typically treats the home as if it is their own; and,
- Guaranteed sale price if tenant exercises their option.
- Setting a ceiling on selling price of the house, especially in appreciating markets (may be very risky);
- The initial due diligence required to screen tenants; and,
- Tenants can walk away from the deal at any time, but investor is bound by terms of the purchase agreement.
- Tenants can “test” the house and the neighborhood and can walk away from the deal at any time.
- Tenants with poor credit can build their credit over the term and build their down payment via rent credits.
- Tenant pays premium rent for the “option” to purchase the house. If the tenant decides not to buy, the option deposit is completely lost.
- Bank financing is not guaranteed at the end of the term. Which may also cost the tenant their option deposit.
From an investors perspective, this is one easy way to make money via real estate. Very little risk and good to great returns on capital invested. For the tenant, this may be a good way to become a homeowner, but there are many risks that one should be made aware of. It is always recommended to own the home than to go through an RTO program. But in some cases RTO does manke sense. It always great to get legal, financial advice and deal with a Realtor that has experience in Rent to Own.
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