About Rent-to-Own or Vendor Financing

What is exactly is Rent-to-Own and/or Vendor Financing?

(Print this article - it's long and contains important information that should be studied if you are seriously considering vendor financing as a buyer or a seller.)

Both of the above terms generically refer to a form of financing for a purchase, such as a home, where the current property owner (or "vendor") provides or agrees to carry the financing or mortgage instead of the bank for a short period of time.

This provides people who would not normally qualify for bank lending the opportunity to acquire and/or control a property until they can arrange their own financing in the not too distant future.

We can help arrange two types of financing, depending on the client's situation and our Realtor's current inventory of properties.

1. Rent to Own, discussed next.
2. Vendor Financing, discussed in the second section below.

What Exactly is a Rent-to-Own?

Generally, a lease-to-own house purchase (also “rent-to-own purchase” or “lease purchase”) is a lease (regular house rental agreement) plus an option agreement, which gives you the right (without obligation) to purchase the property within a specified period, usually 3 years or less, at a price (or price formula) agreed-upon today.

The option agreement gives you control over the asset (house) and for this option, the tenant/buyer pays an option fee, 1% to 5% of the price, which is credited to the purchase price when you buy.

The tenant/buyer pays rent and an additional rent premium, with the premium also credited to the purchase price. Lease-purchase plans make sense in many cases and have a solid economic rationale, which is why they exist.

The "Guts" of a Lease-Purchase Program!

A lease-purchase should have 6 major provisions.

(1) The sale price of the house and (2) the monthly rent are market-determined, yet subject to negotiation just as in a straight purchase or rental transaction, so doing your homework is advisable.

(3) The option period (contract term) is how long you get to get your own mortgage. Buyers generally prefer a long option period because it provides more time to build equity and repair credit. A long period can boomerang on the buyer, however, if they are never able to exercise the option, since they lose the rent premium they have been paying all the while, in addition to the option fee/down payment. Sellers generally prefer a short option period, but if it is too short, the house won’t be sold.

The (4) option fee (some call it the deposit or down payment) and (5) rent premium are viewed differently by buyers and sellers.

To the buyer, they are part of the equity in the house they will soon own. Fully anticipating that they will exercise the option, the only cost is the interest they would otherwise have earned keeping their money in their bank instead.

To sellers, however, these payments are the best guarantee that their houses will sell; if they don’t sell, the payments are retained as income. On balance, these two factors combined give the lease-to-own deal a real possibility of being a win-win.

Finally, a lease purchase may also give the tenant/buyer (6) the right to assign the contract. This will usually have considerable value to the buyer, because it means that the option can be sold in the event that it has value but the buyer is not able to exercise it. In other words, they get the right to  substitute a buyer if they cannot conclude the transaction themselves. It is a cost to the seller for the same reason.

Using a Lease-Purchase to Buy

Firstly, a possible alternative to a lease-purchase deal for consumers with poor credit but cash for down payment is a “sub-prime loan”. Sub-prime loans are more expensive because there is additional risk associated with the borrower. However there are some available at reasonable rates from private lenders and local finance agencies. Borrowers can use the services of a qualified mortgage broker to search out these sources, but be careful as lender and broker fees can often exceed the option fee in a lease-purchase and do not credit your down payment!!  If you can qualify for a traditional mortgage right now or very soon, you may prefer that route instead of a lease-purchase.

The lease-purchase offers homeownership opportunities to consumers who can’t qualify for a loan from any source, but who are prepared to bet on themselves. The bet is that before the option period expires, they will qualify for the mortgage they need to complete the purchase. During the option period, they have the opportunity to build or rebuild their credit and accumulate equity while living in the house.

Consumers who need to rebuild their credit rating during the option period should understand that paying their rent on time won’t do it. Rent payment information is not used in compiling credit scores. While some lenders may assess a borrower’s credit in part based on “non-traditional credit data,” your credit score does not include rent payment information. Lease-purchase buyers who need a higher credit score to qualify for traditional lending must focus on improving their credit scores.

Even though it appears costly (risk of loosing down payment), the right to not exercise the option to buy is of value to buyers. If there is something not quite right with the house, neighbourhood, or neighbours, or there is a potential that you may have to move for work or other reasons, the money left behind on a lease-purchase could easily be less than Realtor fees and a mortgage payout penalty, had you bought instead and had to sell quickly.

Another considerable benefit to the buyer in a market where housing prices might fall is the ability to limit your downside risk to your foregone option fees. In the 2007-2009 correction in housing prices, the option buyer was the BIG winner, walking away in position to buy elsewhere at much lower prices. Conversely, when prices are rising, the option locks in the purchase price relative to the market when the contracts are signed.  In 2005 and 2006 in particularly, market prices increased substantially and, once again, the option buyer came out ahead having secured the right to purchase the property at a price much lower than the current market prices.

Using a Lease-Purchase from a Seller’s Point of View

Most home sellers want a cash sale, but for those able to hang on to the property awhile longer, the benefits can be compelling. By agreeing to help buyers, who would otherwise remain renters, get into their own homes early, they can generally expect buyers to pay full price, perhaps including some assumed future appreciation. To be sure, the deal may fall through, but in that case the seller gets to pocket the option fee and rent premium as consolation. The seller may also enjoy a tax deduction on his mortgage interest payments during the option period.

What types of sellers would benefit from this program?

• Sellers who want to purchase their next property prior to having a firm sale on their current house, duplex, townhouse, condo, or acreage, even mobiles!
• Sellers who are considering renting out their house, but do not have the expertise, time or desire to manage tenants properly.
• Sellers/FSBOs who cannot afford Realtor fees or mortgage payout penalties.
• Sellers who do not need the cash immediately and would consider a steady monthly payment instead, secured by real estate titled in their own name.

Why would a Seller consider selling via our Rent-to-Own Program?

• It makes it possible for the Seller to move forward with other plans - today!
• Mathematically, the could end up as if they had just sold today or better!
• Leaves their property in the hands of a properly screened tenant (our job) who wants to own and will maintain it as if and until it is their own.
• Gets the property sold!
• Seller can still qualify for their next mortgage using the lease income to offset expenses.
• Where equity exists, Seller may be able to access the equity with a refinance, perhaps for the next down payment.
• Ends the wait that is costing them unnecessary expenses and aggravation.

As you can see, there are plenty of good reasons why both buyers and sellers might find rent-to-own attractive. If you would like to get more information on this program as a buyer and join our buyers' list, please complete our Client Questionnaire to get the ball rolling. You can also view available properties.  Sellers, please contact us as well if you think this might work for you.

Another benefit of seller financing to an owner is, after the sale of the home, s/he would be receiving a steady monthly income. In some cases, owners can avoid or spread out paying capital gains tax on the sale of their property by delaying the ultimate sale of their property.

A critical component to buying a house with vendor / seller financing is the name that will appear on the property title. Under a VTB mortgage, the buyer is immediately on title. In an Agreement for Sale, only when the buyer is able to arrange his own mortgage and pay out the entire loan balance to the seller, does title to the property officially and rightfully transfer. Prior to that, however, a seller will often want to remain on title for security until substantial payments have been received. This reduces the risk of non-payment and default by the buyer. The buyer can protect his interest in the property by registering a caveat on title, which prevents the title from transferring to a different party without his or her knowledge.

As very few owners are willing to carry financing for more than a couple of years, it is imperative that the buyer take the necessary steps to get their finances in order such that they can qualify for their own mortgage.

If a seller/owner decides they no longer want to collect the payments, the owner can sell the note on the house, a process called "note buying", to a company (say, a private finance company) that provides such a service. In such cases, the owner will receive a lump sum payment instead of collecting payments over the life of the loan. The finance company then assumes control of the title and John and Linda, from our example, will begin paying them instead until they can arrange their own mortgage and title finally transfers to them.

Seller financing carries more risk to the seller and a lengthy foreclosure-type process is often the only remedy for buyer default unlike a lease-purchase agreement, where the buyer/tenant looses the right to exercise their purchase option and is simply evicted for breach as provided for in the Residential Tenancy Act. The increase in risk under seller financing, dictates that the buyer be able to provide a much higher initial down payment so that they have significant "skin in the game" hence sufficient motivation to complete the purchase transaction.

Next Steps:

If you are a buyer and would like to get more information on this program and join our buyers list, please complete our Client Questionnaire to get the ball rolling. You can also click here to view available properties.  Pretty much any property available for rent-to-own would be available for Agreement for Sale or Vendor Take Back mortgage provided terms acceptable to both parties are negotiated.

MLS listed properties.  The vast majority of sellers (and many Realtors) are unaware of vendor financing techniques to buy and sell properties.  If you see a MLS-listed property of interest, please contact us with the MLS#.  We will review your financial situation, and, if you are a reasonable candidate for this type of transaction, we will approach the listing Realtor on your behalf.