How does rent to own work for houses

A perfect storm of rising living costs, "low and slow" wage growth and increasing house pricesis 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.

What is rent-to-own?

Rent-to-own schemes (also known as rent-to-buy) are leasing agreements that allow tenants to purchase a property at the end of a lease period at a previously-agreed-upon price. 

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 property price rises, 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. 

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

How do rent-to-own schemes work?

Rent-to-own schemes have two components: a standard rental agreement and an option to buy. It's important to seek independent legal advice before signing anything and also understand the rules around these schemes in each individual state.

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.

Rent-to-own cost example

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.

Pros and Cons of Rent to Own

While everyone looking into rent-to-own has different and unique circumstances there are a few general pros and cons to rent-to-own schemes that they should know about before signing anything.

ProConThe purchase price is set so buyers can plan for it.Property market fluctuations may mean the value goes down before you purchase it.You can live in the property before you commit to buying it.Rents are typically higher than the market median for the suburb.Depending on your agreement you may be able to pay some of the purchase price down as a percentage of the rent you pay each month.Tenants could be financially responsible for fixing things that go wrong with the property during the rental period.Renters have fewer rights over the property than owners.Finance is still required at the point of purchase and tenants could risk losing the home if home loan approval isn't granted.

Potential benefits of rent-to-own

Purchase price set upfront

One of the worst things about trying to save for a deposit while renting is that the property market will generally continue to rise, which means it can take even longer to save the required amount.

In the case of rent-to-own, the purchase price is set upfront so buyers can plan for and save the required amount for the deposit as well as organise finance with a lender.

You can try before you buy

Another attractive element of rent-to-own is that (prospective) buyers can get to know a property as a renter before they commit to buying it.

There's nothing more daunting than finding out a few weeks into owning a property that it's not the dream home you thought it was.

Depending on your agreement you'll be able to negotiate exiting your agreement without being forced to buy anything you don't want to.

Some of your rent may go towards paying down the primary balance

Depending on your agreement, some tenants may be able to start paying down the primary balance, which - any mortgage-holder will agree - is the name of the game.

Once that primary amount starts decreasing then your financial situation is suddenly a lot easier. One of the reasons for this is that it decreases your LVR, which means you'll pay less over the life of the loan.

Potential downfalls of rent-to-own

The property could drop in value despite the locked-in price

While in the long term the property market does tend to increase in value, the reality in the short term might not be as optimistic.

Property values, like with any market, are bound the affects of supply and demand and have been known to go down as well as up.

Rents are higher

Living costs for rent-to-own schemes do tend to be higher than the median rental prices

'Option to buy' fees are typically between 1-5% of the purchase price.

You may need to cover repairs

Despite being a tenant and depending on your agreement you may be responsible for pay for repairs and maintenance on the property.

Always make sure you fully understand your agreement to make sure you don't get any nasty surprises.

Tenants aren't on the title

Owning a property comes with a complex set of legal parameters that are different from being a renter.

Having the land title in your name allows for some protection for owners that does not extend to tenants, such as having access to any equity on the house.

This leaves renters vulnerable to eviction if they cannot pay their rent, whereas owners could draw down on the equity if circumstances demanded.

Before signing a rent-to-own contract it's important for tenants to understand what happens if something goes wrong and the contract is terminated either because the tenant is at fault or the owner goes bankrupt.

You still need to be approved for finance

One of the biggest hurdles for any buyer is getting approved for finance and this is no different for those taking part in rent-to-buy schemes.

Make sure you've put yourself in the best possible light for being approved and if you're not sure then consider speaking to a mortgage broker who can help get everything ready for the application.

You should also have a good understanding of what happens if finance isn't granted and where that leaves the agreement with the rent-to-buy provider. If you've paid higher fees or rent to have the option to buy then be sure to know what happens to these if finance is rejected.

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

Current rent-to-own developments in Australia (2022)

• Assemble Communities have projects in Melbourne and Ballarat that offer a range of housing options.

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.

First time renters:  a guide to moving out of home

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.  

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