Windfalls, pitfalls of rent-to-own

21 Apr 2009

With banks now insisting on large deposits before granting home loans, many buyers are looking at other purchase options, including rent-to-own agreements.

And in theory, says Dr Willie Marais, national president of the Institute of Estate Agents (IEASA), both parties to such agreements win. For the would-be seller, the advantages include:

- The opportunity to tap a broader market of potential buyers, not just those with excellent credit and cash for a deposit;
- Rental income to cover the existing mortgage and an opportunity to lock in the property's price that might otherwise fall in a down market;
- A tenant with a vested interest in keeping up the property because it will soon be their own.

For potential buyers, the biggest positive is obviously being able to move immediately into the home they want, and live in the area of their choosing, without having to hand over a large cash deposit.

The idea of a rent-to-own agreement is for the buyer/ tenant to rent and maintain the property for a set period of time before he must obtain a home loan and exercise an option to purchase – or decide to walk away from the deal.

Typically, such a transaction will comprise three agreements, being an Option to Purchase (which allows the buyer a certain period in which the option can be exercised by signing the Sales Agreement), with as annexure a Lease Agreement, and a Sales Agreement. The Lease Agreement needs to comply with the Rental Housing Act, and all the details of the sale, such as the purchase price, need to be agreed on and be contained in the Sales Agreement, which is signed initially by the seller only.

The home seller/landlord will normally charge an "option fee" equal to between 1% and 3% of the home's purchase price, but then allow the buyer/tenant to pay this off monthly as part of the rent, and agree to credit all or most of it as a deposit on the property at the end of the rental period.

"This all seems straightforward, but there are many potential problems for the unwary. It is quite possible, for example, that the tenants will decide at some stage that they don't really want the property after all and just give up on maintenance for the remainder of their lease period – leaving the landlord with the prospect of a hefty cleanup bill before he can put the property back on the market.

"And from the buyers' point of view, there's the danger that they won't be able to qualify for a home loan within the timeframe of the rent-to-own agreement and may lose any option money that they have paid either upfront or as a portion of their monthly rent.

"Unscrupulous landlords have been known to charge high option fees and then look for any opportunity to cancel the contract – late rent payments, for example – so that they can evict the tenant, then find another potential buyer and take another option fee."

Consequently, he says, those who are considering entering into a rent-to-own agreement should not do so without the assistance of an experienced estate agent and a reputable mortgage originator, as well as the advice of their attorney on the implications of the contract.

They should make sure they receive satisfactory answers to the following questions before signing on the dotted line:

- Is the purchase price a fair price given the future price expectations?
- What portion of the rent, if any, will be credited towards the purchase price of the home?
- Who will be responsible for the rates and taxes on the property during the lease period?
- Under what conditions could the rent-to-own contract be avoided?
- Under what conditions could the buyer be refunded any part of the option fee?

"And finally, if the lease period is more than a couple of years, potential buyers should think hard about how their finances might change in that time. It might actually be easier and quicker to rent more cheaply while saving for a deposit and then enter into an ordinary purchase agreement."

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