The Pros and Cons of Rent-to-Buy: What You Need to Know
Although not a conventional and familiar method of purchasing, or selling a property, a rent-to-buy agreement is a process in which a buyer commits to renting a property for a specified period of time, with the option of buying the property.
The seller and the potential buyer sign a rental agreement for a specified term, at the end of which, the tenant will be able to choose whether or not to purchase the property.
While more complicated than a standard leasing agreement, it provides an opportunity for the potential homeowner to build up the necessary capital required for ownership as well as establish a sound credit record.
How does it work?
Before both parties consider entering into this type of agreement, the tenant must be able to prove that they are financially qualified to be able to buy the property; if a mortgage bond is required by the buyer to obtain the necessary finance, it is advisable that the buyer produce an approval from a financial institution proving eligibility.
The tenant and the landlord must sign a lease agreement that stipulates all the terms and specific conditions of the agreement including the lease duration, deposit and monthly rental payment.
In some cases, the parties may agree that the prospective buyer's total rental costs during the lease period will be subtracted from the purchase price should they go ahead with the purchase at the end of the lease.
Furthermore, the agreement must incorporate the responsibilities to be fulfilled by the prospective buyer which may include paying rates or levies which are typically the responsibility of the owner and/or maintenance and repairs of the property.
On conclusion of the agreed-upon lease term, the tenant can decide whether or not to purchase the property. However, should the tenant wish to buy the property during the lease, the agreement should specify at what point he or she will be eligible to buy.
An OTP (Offer to Purchase) can also be attached to the lease which will include all the usual terms and conditions of a sale, and only come into effect once the option to buy has been decided upon by the tenant.
What are the pros and cons as a buyer?
Advantages:
- The selling price of the property is determined and fixed at the beginning of the lease agreement, therefore the seller cannot inflate the agreed-upon figure should property market values change.
- Depending on the agreed lease term, this provides the time to arrange all legal documents, fees and deposits required for the purchase.
- Unless renting the property fully furnished, there will be no additional moving costs.
- Should the buyer decide to undertake any renovations or improvements to the property once transferred they can obtain quotations upfront and set aside additional savings.
- If young or a first-time home buyer, it's the perfect way to strengthen your home loan application.
Disadvantages:
- Should the buyer default on rental payment for any reason, this may result in the loss of rights to purchase and any amount of funds that may have been amassed towards the purchase price.
- In case of emergency, relocation or other unforeseen circumstances, the buyer could stand to lose any monies paid during the lease period towards the purchase, depending on the terms and conditions of the signed contract.
- The monthly premium paid during the rental term is generally higher than the market rental rate for the property, making it more difficult to save for a deposit or afford other expenses, such as repairs and maintenance while renting.
- If at the end of the lease term, the decision is made to not purchase the property, the buyer may forfeit any fees or deposits paid upfront.
- Until the transfer is processed, the property will remain in the seller's name which means the buyer will have limited options when it comes to any additions or renovations made to the property during occupation.
- As the property market can be unpredictable, should property prices fall, there is a possibility the buyer may purchase the property at a relatively higher price than the prevailing market conditions.
What are the pros and cons as a seller?
Advantages:
- As a seller, you are likely to attract a higher quality buyer who is committed to maintaining the property as their future investment and they stand to lose money if they cancel the agreement.
- To cover any increases in property values during the rental period, the seller can opt to set a higher sale price upfront
- Rather than covering ongoing expenses on an empty property, the seller can be assured of incoming revenue during the rental process
- Should the buyer renege on the terms and conditions of the agreement or withdraw, the seller retains the upfront fees paid by the buyer.
Disadvantages:
- Unless fully outlined in the agreement, there is a risk that the buyer may not maintain the property during the rental period which could lead to an altercation between parties as to whom will cover the cost of the repairs.
- An additional increase in expenditure for home insurance should be considered just in case the property gets badly damaged before it is finally sold or if the offer to sell is withdrawn.
- The seller could decide to take the property off the market in the belief that the signed offer can be accepted as sold, which prevents negotiations with other potential buyers who may be willing to buy the property at a higher price.
- There is always a possibility that the buyer might default on their rental payments which could leave the seller in a financial predicament.
In Closing
Although the rent-to-buy option is often mutually beneficial, there are many factors to consider before signing this type of contract and thus, it is advisable that thorough research is done by both parties to gain a clear understanding of all terms and conditions before signing any agreement.