Rent to Own, Rent to Buy

A standard residential lease (Residential Tenancy Agreement) is used to give possession to the Purchaser.
The purchaser pays rent under the lease.
The purchaser signs an option to purchase the house in 2 or 3 years, at a price fixed up front.
The purchaser pays for the option, by paying up front and ongoing option fees.
The purchaser’s payments are credited (as debited) against the price payable under the Contract.
The purchaser may “earn” the part of price using “sweat equity”, by carrying out work on the property.

Tenant/Purchaser’s Guide to Rent to Own

Q What is Rent to Own?
A Rent to Own is a path to home ownership which you can walk down if you would like to
   purchase a home. Taking the path involves renting a while, and buying later on.

Q How does Rent to Own Work?
A Renting for a while, and building up a deposit is the renting part. Qualifying for a home loan at
   the end of the renting part and signing a purchase contract will be the buying part.

Q How does the renting part work?
A The renting part uses a standard Residential Tenancy Agreement, which is the proper name for
   the rental agreement that is signed to rent homes everywhere. The rental agreement requires
   the payment of a rental bond, and then payment of rent weekly, fortnightly or monthly over an
   agreed time period. The rental agreement contains the standard safeguards found in all rental
   agreements, such as the right to remain in the home provided the rent is paid on time. A
   condition report is filled in at the time the key is handed over, to minimise disputes about the
   condition of the home.

Q How does the buying part work?
A The buying part is separate – it is a separate agreement called an option deed, commonly
   known as an option. The option gives you the right to purchase the property, but not the
   obligation to purchase the property, by the end of an agreed time period. The option requires
   the payment of an up-front option fee to secure the option, and then payment of ongoing option
   fees at the same time as the rent is paid, over an agreed time period. The option allows the
   crediting of the up-front option fee and the ongoing option fees against the purchase price for
   the property, if you decide to go ahead and convert the option into a contract for purchase of
   the property. If you don’t go ahead and purchase the property, these option fees are lost, just
   the same as rent payments are lost under a rental agreement. The technical phrase for
   converting the option into a purchase contract is ‘exercising the option’. The price is pre-agreed
   at the start so that if the property value increases, the tenant purchaser keeps the capital gain.
   This is the trade-off for the option fees being non-refundable.

Q So how does the price credit/deposit build up?
A The option fee payments under the option are treated as a price credit/deposit paid on the
   contract for purchase of the property, if the option is converted into a purchase contract. The
   rent payments under the rental agreement are not credited towards the deposit. Because the
   purchase of the property must be financed by a lender (such as a Bank), you must be able to
   show a deposit of 5% or 10% of the price – the price credits received for the option fees
   gradually build up the deposit, until either 5% or 10% has been built up. In addition, the
   capital gain on the property might be used to build equity for the Bank to lend on.

Q How do I show the Bank that I can afford the loan repayments?
A If you add the rent and the option fees together, they will be not too far different from the
   amount of the loan repayments that will need to be made under the Bank loan. Provided a
   good track record of regular payments can be shown, then the Bank will consider you to be
   ‘creditworthy’ and able to qualify for a Bank loan. Depending upon your credit file defaults, and
   employment situation, this process of building up a good track record can take two years.
   This means that Rent to Owns are often two year periods, with extensions for another year.

Q Can you provide a Rent to Own example?
A Yes – assume the target is to be able to rent for two years, then purchase the home for
   $300,000 at the end of two years. Buying the standard way, an upfront deposit of $30,000
   (i.e. 10%) would be required, plus about $5,000 in purchase expenses. Buying the
   Rent to Own way –

• An up-front option fee of $10,000 is paid – that, plus the rental bond is all the money that is needed to be paid up front.
• A rent of $350 per week is paid, and in addition a $200 per week ongoing option fee is paid. The total weekly payment is therefore $550 per week, which is deducted by direct debit authority or paymaster’s authority.
• After two years, the price credit is the up-front option fee of $10,000, plus two years worth of ongoing option fees – 104 weekly payments of $200 each, a total of $20,800. Add the two together, the total is $30,800, which is slightly more than 10% of the agreed price of $300,000. Note the price remains fixed. The ‘left-over’ $800 can be used for purchase expenses.
• At the two year point, with a price credit of $30,800 to be used as the deposit, the Bank lends $270,000 (i.e. 90%) and the purchaser is able to buy the property.
• First Home Purchasers will normally be able to receive a First Home Owner Grant and an exemption from stamp duty, when they enter into the purchase contract.

Q How do I start?
A Find a property that is advertised as a Rent to Own, Rent now, Buy later, and complete the
   application. The owner will ask for a copy of your individual credit file, and check your work and
   renting history. If you are chosen, you will need to pay an establishment fee to cover the cost
   of the documentation. Once you have signed the documentation, you can make arrangements
   to move in.

This information has been provided by Anthony J Cordato, a solicitor who specialises in vendor finance for real estate, and whose website is www.vendorfinancelawyer.com.au