The perfect storm of skyrocketing living costs, stagnant wages, and rising house prices has made the Great Australian Dream feel more like a mirage for many.
What's a would-be homeowner to do?
Enter rent-to-own (sometimes called a rent-to-buy) home schemes, a rather nifty alternative that is popular overseas has been starting to gather some momentum in Australia.
Here I’ve covered everything you need to know about how to rent to own a home.
Rent-to-own home schemes, also known as rent-to-buy, are leasing agreements with a twist.
It lets tenants buy the property at the end of the lease period at a price at a previously agreed-upon price that’s locked in from the beginning.
But, it’s not all rainbows and butterflies.
More on that later.
This arrangement makes it easier for aspiring property owners to get onto the property ladder by eliminating the need to save a traditional deposit and delaying the need to secure finance from a bank or lending institution.
Additionally, by fixing the future sale price, rent-to-own schemes protect the buyer from future property price increases.
However, this can work against the buyer if the market experiences a downturn during the rental period.
Participants don't own any part of the home until they've made the final payment, and 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 usually have two components: a standard rental agreement and an option to buy.
Aspiring homeowners sign a contract with a vendor, giving them the right to buy the property at the end of an agreed rental period, which typically ranges from two to five years.
These schemes often require a deposit, which aspiring homeowners sometimes secure by applying for the First Home Owners Grant.
During the rental period, participants pay rent, usually above the market average, plus an ongoing fee for the 'option' to buy the property at the end of the contract.
Sometimes you might also be on the hook for things like maintenance, stamp duty, and insurance, so read the fine print.
The total money paid for this 'option to buy' is usually deducted from the final sale price.
Renting to buy a home is suitable for those who can comfortably make the rent payments, but aren’t able to save enough to accumulate a 20% deposit, plus additional costs, of buying a property.
Rent-to-own (or rent-to-buy) schemes are split into two components: the rent phase and the buy phase.
The first ‘rent phase’ of a rent-to-own scheme is where a prospective homeowner who wants to buy a property through a rent-to-own scheme looks for an eligible property they will eventually want to buy.
Once the buyer has settled on a property, they would then sign a contract with the vendor which outlines their right (not their obligation) to buy the property at the end of an agreed rental period (usually 2-5 years) for an agreed price.
The contract will state how much of the rent payment will go towards building equity in the property, the term of the rent phase, the purchase price, the rent amount, and any ongoing fees incurred for getting the option to purchase the property through a rent-to-own scheme.
It’s worth noting that the rent will usually be at an inflated price over the course of the contract in order for you to achieve more equity sooner.
Under some rent-to-buy contracts, prospective owners also need to cover the costs of things like building maintenance, stamp duty, and insurance.
Once the rental term has come to an end, the buyer will enter into the ‘purchase phase’ of the agreement.
At this point, as long as there have been no defaulted payments, the renter can use their ‘option to buy’ and use any equity they have accrued on the property as a down payment and secure finance for the remaining balance.
As with any usual purchase, your financials and credit rating will need to be in good order to achieve approval to borrower the remaining balance of the property.
Note: Rent-to-buy schemes are contracts, and as with many contracts, if a renter defaults on just one payment it is enough to void the entire contract, losing both the opportunity to buy and any monies paid towards the equity.
There are various different types of providers offering rent-to-own schemes, and each of their offerings differs.
In general, they can be split into two main models: rent-to-own established properties and building rent-to-own properties.
Rent-to-own established properties
This is the most common model that many would use.
Targeted mainly at first-home buyers who are unable to save a deposit for their first home, some providers will use this model to buy the home on their behalf, then rent it back to them at an agreed inflated price, with an option to buy for a set price at the end of the lease period.
For example, Commonwealth Bank-owned OwnHome will buy a property an eligible applicant wants (up to $1.8 million) and lease it to them for 3-7 years before selling at an agreed price taking into account a 0.32% increase per month.
The buyer also has to pay a starter fee of 2% of the property’s value which will not go towards equity in the property.
There are also providers offering an alternative rent-to-buy model for a brand-new property.
Instead of buying an established property, some developers will essentially allow eligible applicants to rent a new property from completion for a set lease period before agreeing to buy for a set price.
For example, Assemble Communities, a developer in Victoria, has its own “build to rent to own (BTRTO) housing model” which is where tenants wait 2 years for an apartment to be built, rent it for 5 years then have the option to buy at an originally agreed price.
The cost of using a rent-to-buy scheme varies significantly depending on the model, the provider, the property itself, the location, the length and cost of the lease, and the terms of the contract regarding how much goes towards equity.
Generally, applicants will have to pay an upfront fee, an inflated and above-market rent, plus any costs, plus the final price to purchase the property.
The total amount paid over the rental period is usually then deducted from the sale price.
Here are a couple of examples of what that might look like.
You agree to buy a $600,000 property after renting for 3 years and you pay a weekly $100 fee on top of your inflated $800 per week rent.
The contract states that both your fee and half the rent paid will go towards equity on the property.
That would mean that at the end of the last period you would have paid $140,400, $78,000 of which can be used as equity towards the property.
The final sale price, and therefore the amount you’d need to finance, is $522,000.
The total cost of buying a $600,000 property in this instance would be $662,400.
Imagine a three-year rent-to-own agreement with an agreed future price of $450,000.
You pay a $28,000 deposit, $20,000 of which comes from a First Home Owners Grant, and agree to pay an inflated $600 per week rent for 3 years plus $100 per week for the option to buy the property at the end of the lease.
Under your contract, only the $100 lease fee will go towards the equity in the property, none of the rent is applied.
You will have paid $109,200 over the lease period but you will have $43,600 in equity.
The final purchase will be $406,400.
This would take total costs to buy a $450,000 property to $515,600.
[note]All contracts vary significantly so make sure you have it checked by a solicitor so you know exactly what you’re paying and how much of your payments is going towards the final payment price.[/note]
There are a number of significant benefits of using one of these schemes and renting to buy a home.
- No 20% deposit needed: As I mentioned above, these schemes eliminate the need to save a traditional deposit - this is one of the most time-intensive parts of buying a property.
- Delayed need for finance: A rent-to-own scheme delays any need to secure finance until the end of the lease is up. So this gives would-be buyers extra time to get all their financial ducks in a row if they need to.
- No obligation: The contract will set out an ‘option’ to buy, not an obligation. Once you reach the end of the lease agreement you only buy the property if you want to. There is also the option to waive your rights.
- Locked-in sale price: The contract will set out an agreed sale price for when the lease agreement ends. Even if this takes a small annual increase into account, a locked-in price can be very beneficial in a booming market.
- Capital gains: You can start to capture capital gains before you even own the property. By paying towards the property from day one, renters are building equity in the property almost immediately.
- You may avoid some extra costs: Depending on the provider who bought the property and who you’ve agreed to your rent-to-buy scheme with, you might not need to cover the additional costs of home ownership until you sign on the dotted line - such as strata fees, repairs or insurance.
- Treat it as your home: The plan is the property will be 100% owned by you in due course, but you can treat it as such from day one. This means you can renovate, paint and make changes as you wish that you wouldn’t be able to do in a standard rental property.
Sure there are many benefits of buying a property through a rent-to-buy scheme, but there are also just as many risks to keep in mind.
- No ownership in the lease: This is the most significant risk, a renter has no ownership, even in part, of the property until they have made the final payment.
- You could lose money: If you default on a payment, void the contract in another way, or decide not to buy at the end of the lease then you forfeit all the monies paid during the rent phase. That could equate to a significant loss.
- Your situation could change: No one has a crystal ball, so it’s impossible to predict your financial or life situation in 5 years’ time - the option to buy when the time comes might no longer be favorable or even possible.
- You still need to be approved for finance: Securing finance is one of the biggest hurdles for any buyer and it’s no different for buyers using a rent-to-buy scheme. IF your finance is rejected you may not be able to purchase the property after all, meaning you forfeit any equity you’ve built in it through rent payments.
- The market could turn: You could also lose money if the market turns without warning. A locked-in price won’t look so favorable if markets have fallen by the time it's time to pay up. You could end up paying more than the property is worth.
- Capital gains aren’t guaranteed: There is no guarantee that the property will grow in value as you expect.
- High rent: Because of the nature of the rent-to-own schemes, rent is paid at an inflated rate meaning it's more expensive than if you rented another usual rental property elsewhere.
- You’re at the mercy of the provider: Because a provider owns your property, and you’re paying them to rent with the view of later buying it back, you’re heavily reliant on that provider meeting its end of the agreement. It's important to know your rights if the provider were to fall into liquidation or bankruptcy.
If you’ve decided that a rent-to-own scheme is still for you, then here is a 7-step guide to get you through the process.
Step 1: Find a property you want to buy
The first step you need to take is to look for a property you want to buy.
The supply of properties available for purchase under a rent-to-own scheme is very limited so a property hunt will likely take longer than if you’re looking to buy a property on the open market.
Some providers will have a list of properties available that they have already purchased that you can choose from.
Step 2: Do your research and due diligence
As with any type of property purchase, it’s vital that you do all your research and due diligence.
Research the suburb, the street, the type of property, local prices, and any potential gentrification.
You need to ensure that you’re making a good investment decision, not just going with any property available to you at the time.
Step 3: Research the provider
This is another vital step because your finances and your potential future homeownership lie in the hands of the provider that you sign a contract with.
If the provider becomes insolvent, they will take your money and any potential to buy the property, with it.
Step 4: Sign onto a rent-to-own contract
At this point, you’ll want to get independent legal advice from a solicitor or conveyancer.
A solicitor should look through the entire contract to ensure you know exactly what you’re getting, what you’re expected to pay, and how much of what you pay goes towards the property’s equity.
Once you’re happy that you fully understand and are happy with the terms of the agreement it’s time to sign on the dotted line.
You will need to pay a deposit at this point too as per the agreed terms of the contract.
Step 5: Start renting the property
The next step is simple - move in and treat the property as if it is your own.
It’s important to keep up to date with all rental payments to avoid running the risk of voiding your contract and losing any entitlements or banked money.
Step 6: Secure financing for the remaining balance of the property
Once the lease period has finished you have the option to buy the property.
At this point, you’ll need to secure finance for the remaining balance for the agreed final sum as per your contract.
Step 7: Pay the final installment - the property is now yours
Once your finance has come through, and the payment has been made to the rent-to-own scheme provider, then congratulations, the property is now 100% yours.
- Also read:Heat comes out of the housing market as values across Melbourne dip and Sydney slows | Corelogic Home Value Index
- Also read:Latest property price forecasts for 2024 revealed. What’s ahead in our housing markets in the next year or two?
- Also read:Sydney property market forecast for 2024
- Also read:Home Price Growth Still Strong Over November | Latest Housing Market Stats
- Also read:Boom to bust: What makes property prices rise and fall
If you think you’ll struggle to buy a home the traditional way, but aren’t sure if a rent-to-own scheme is for you, there are some other alternatives depending on your personal and financial situation.
Low or no deposit home loans mean that buyers with as little as a 5% deposit are able to get onto the property ladder sooner by paying lenders' mortgage insurance instead - this is a premium which is added onto your total loan size as insurance for your defaulting on repayments.
Low-doc home loans are available for borrowers who don't have pay slips from a salaried job.
Instead, lenders will accept different proof of your income such as business bank statements, business activity statements, or income declarations.
Bad credit home loans are available to Aussies who have a poor credit history.
Typically these will be at a higher interest rate, higher fees, and require at least a 20% deposit.
State and federal government incentives are available to many first-home buyers struggling to get onto the property ladder.
You may be eligible for anything from stamp duty waiver to a first home guarantee, help-to-buy, or others.
It’s worth exploring any eligibility which might help you buy a property sooner.
Note: With high prices, dwindling borrowing power, and soaring interest rates, stepping onto the property ladder for the first time might seem to be slipping further out of reach for many Aussies.
And while there is the option to use a rent-to-own scheme to get onto the property ladder, and it comes with many perks, they can be expensive and there are also many risks involved.
Before going down the route of one of these schemes, make sure you speak to an expert such as the team members at Metropole to ensure your potential property purchase makes good investment sense.