Consumers are quite familiar with the concept of rent-to-own. The strategy offers a way for people to rent or lease things they can’t afford to buy outright. The idea of giving people the use of something today without having to buy it first is the same concept behind lease-to-own (LTO) homes.
A Canadian lease-to-own home offers some distinctive advantages that make it a smart strategy for someone who can’t qualify for a mortgage today. We describe five of these advantages below.
Save a down payment
The goal of a lease-to-own home is to give a qualified renter the tools to purchase a home sooner. A tenant leases a house that he eventually wants to own for a specified period of time to do two things: create a down payment and fix your credit.
In Canada, a prospective homebuyer currently needs a down payment of at least 5% plus closing costs to qualify for a mortgage and CMHC (Canadian Mortgage and Housing Corporation) insurance. The first advantage of a lease-to-own home is that it acts as a forced savings plan because a fixed amount of the lease payment is set aside each month. A typical Canadian LTO helps a tenant save enough money at the end of the lease term to qualify for a CMHC-insured mortgage.
personal credit repair
The other half of the leasing-to-own picture is helping a tenant repair their credit. Sometimes a tenant can do this simply by making their monthly lease payments on time. Other times, they may need to work closely with a credit counselor to rebuild their credit score or reduce existing debt during the term of the LTO.
The combination of a good credit score, low debt, and a reasonable down payment will help a tenant get the banks to say yes when applying for a mortgage. They will also have obtained an education in financial management and at the same time will become more attractive to lenders in the future.
Fixed lease payments
The third advantage of a lease-to-own home is that the monthly lease payments are fixed for the entire lease term. A normal rental agreement in Ontario allows the landlord to increase rents by a certain amount once every 12 months.
This is not done with a lease-to-own agreement because increasing monthly payments by any amount could affect their affordability to the tenant. A fixed monthly lease payment gives renters cost certainty and allows them to budget knowing their basic housing payments will not increase.
Guaranteed purchase price
In addition to a fixed monthly lease payment, a lease-to-own agreement also fixes the future purchase price of the home. This is done with the help of a licensed Ontario mortgage professional when a tenant is approved for an LTO home, as well as a licensed real estate agent once the tenant finds the home they eventually want to buy.
Before deciding what the final purchase price will be, the tenant’s current household income, outstanding debts, what they can reasonably afford to buy, and historical appreciation in the chosen neighborhood have already been considered. Accepting the price up front gives the tenant peace of mind that his deposit will be enough to buy the house, regardless of its actual value.
Generate instant capital
Once a tenant is approved for an LTO home, they are required to put down a non-refundable security deposit, currently 2-3% of the approved purchase price. This deposit is eventually counted toward the final down payment giving the tenant equity in the home from the day they make their deposit.
However, a tenant is not limited to the equity created by their down payment. Most homeowners will usually make some sort of upgrade to their home, whether it’s a backyard deck or new cabinets in the kitchen.
The same is often true in a lease-to-own agreement because a tenant does not have to wait until they can buy the house to start making improvements to it. With the owner’s approval, they can make improvements that will generally increase the value of the home and create additional equity for them when they purchase the home.
A tenant who can’t qualify for a mortgage today can use a lease to own to purchase a home in as little as 24 to 36 months. This strategy helps renters save a down payment and repair their credit. Fixed lease payments and a guaranteed purchase price give them cost certainty. The fifth and perhaps most attractive advantage for renters is the ability to increase the value of your home before you own it and possibly lower your CMHC insurance premium in the process. Then it is possible to have your cake and eat it too!