Rent to buy, also known as rent to own, is a pathway for potential homeowners to navigate the high cost of housing in Australia, especially when they don’t have the required deposit to access a home loan.
At the same time, these schemes are not without their risks. Therefore, it is essential to understand how these arrangements work before signing on the dotted line.
This article provides an overview of rent to buy schemes, how they work in Australia, and whether this option is best for you.
What is Rent to Buy?
Rent to buy schemes are essentially lease agreements where you have the option to purchase the property once your rental term ends (usually 3-5 years) at a previously agreed-upon price.
While living in the rental property, a portion of your rent payment is used towards paying off your home. The outstanding balance amount is then paid at the end of the agreed rental period.
The pre-agreed price is usually inflated so that it covers any property price rises in the future. In addition, by agreeing on the future sale price, home buyers can negotiate a good deal that protects them from steep property price rises.
Notably, you will not own any part of the home until you’ve made the final payment. In addition, you’ll most likely still have to apply for a home loan to buy the property at the end of the rental period.
“The rent to buy model is widely popular in the US among aspiring homeowners. However, here, in Australia, there are limited players in the market, and they have their payment models and niche target groups,” says Graeme John, Head of Growth at Joust, adding insights on the current scenario of the rent to buy industry in Australia.
The Option Fee and the Rent to Own Agreement
As a renter, in most cases, you’ll have to pay an upfront fee known as an option fee to the seller. This non-refundable fee allows you to eventually have the option to purchase the home once the rental agreement period has ended.
Here are a couple of things you should remember about option fees when considering rent to own agreements:
- Rate: Option fees are typically between 1%-5% of the total purchase price. This is usually agreed upon by both parties at the beginning of the rent to own agreement. As it’s typically negotiable, you should try to get a suitable deal matching your financial situation.
- Non-refundable in nature: Once the agreed rental period is completed, you (the renter) have the option to buy the property for the previously agreed upon price. If you, however, decide against purchasing the home, you’ll have to forego the option fee. In that case, both parties can exit the agreement without obligations.
- Discounted at the time of sale: If you decide to buy the property, the seller will discount the option fee from the down payment on the property at the time of sale.
Why is Rent to Own Better than Renting?
There are several reasons why rent to own may pan out better than renting.
Here are our top finds:
- Building equity: One of the most critical advantages of rent to own is that - unlike pure renting - rent to own schemes support equity building in your home. So, your rental payments not only pay for a roof over your head but also underpin your financial future.
- Credit score: One of the most common reasons aspiring home owners consider rent to own schemes is their poor credit history is a barrier to getting approved for a typical home loan. With the rent to own, they now have additional time to improve their credit scores. Thus at the end of the rental period, they are much better placed to qualify for a home loan and purchase their own home.
Rent to Own vs Buying
The property ladder can be a tough one to climb. However, many buyers could do it with a little help.
The option to enjoy the property as you go and then own it outright at the end instead of incurring debt early on may suit some best because of:
1. A Hybrid Approach
Rent to own homes are a pathway to buying a home where the entire or a portion of your lease payment goes to equity building in your home. Aspiring home buyers who are not in a financial situation to buy a house because they afford a deposit/make a down payment due to a lack of savings find this a viable option. The rent to buy model also helps you gradually build equity in your home while giving you time to make up if you have a bad credit history. In addition, this will help you qualify for a home loan later.
2. Try Before You Buy
With a rent to own, aspiring buyers can decide on many factors, i.e., if the property meets their requirements, they like the neighbourhood, etc., before taking home ownership and becoming the legal owner. If the house isn’t up to your expectations, then depending on the agreement, you could try to exit the contract without any obligation to buy the property.
How Does Rent to Buy Work?
As the name suggests, the rent to own process can be broadly classified into the following stages:
When You’re a Renter
Once you’ve decided on the rent to buy house you want, you must sign the rental agreement. You cannot claim any legal rights in the property title as a renter.
Over and above your regular rent payments, you may have to pay a non-refundable deposit and an ‘option to buy fee’, often costing tens of thousands of dollars over your lease term.
As the fee is usually built into your regular rental payments, in most cases, you’ll be paying more than the market rent for your house. Further, you may have standard outgoings paid by owner-occupiers—for example, stamp duty, building maintenance, council rates and insurance.
The seller then deducts all these additional fees from the final sale price if you decide to purchase the property. This sum is non-refundable if you eventually exit the rent to buy scheme.
Most importantly, your contract can be terminated even if you miss one rental payment. You’ll risk losing all the money you’ve spent thus far.
When You’re a Buyer
Once your rental term ends and you plan to purchase the property, you begin your journey up the property ladder.
The amount now payable is your property’s purchase price that was agreed upon at the start of the rental period minus the ‘equity’ you’ve built during the rental period.
Like other aspiring homeowners, you’ll need to secure finance by taking a home loan from a bank or lending institution.
Once your application is approved for a home loan to buy property, the title will be transferred to your name. Then, as the legal owner, you begin paying off your home loan.
How Much Does it Cost to Rent to Own?
The costs of rent to own schemes vary significantly. You may likely have to save up around 3% of your purchase price as an upfront option fee, which will go towards your equity.
At the same time, you should be prepared to pay well above the market rent and the added ‘option’ to buy the property once your rent to own agreement ends.
Sometimes this inflated rent can be 50-100% higher than average. In such cases, the increased portion of your rent will primarily go towards growing your equity in your house.
Some rent to buy schemes allow you to lock in a future price guarantee which increases at 3% per year. This is one of the lowest rates offered in this space.
Ultimately, the exact amount of monthly or weekly rent or other rent you will have to pay will depend on the house and suburb you choose.
Rent to Buy Laws in Australia
The laws on rent to own schemes differ from state to state.
While the Consumer Action Law Centre recommended they be banned in all states and territories, only Victoria and South Australia have forbidden them so far.
Victoria
Rent to buy and vendor finance schemes are banned from the Victorian housing market. The historic ban, included in the Sale of Land Amendment Bill 2019 passed by Parliament, aimed at protecting vulnerable home purchasers from unfair exploitation. The ban was brought into effect in March 2020.
The report dismissed rent to own agreements as rip-offs where homebuyers have to incur heavy extra payments over the rent and often end up paying huge sums without any likelihood of becoming home owners.
Other pitfalls cited included confusion about ownership, unclear rights for both parties and lack of consumer protection compared to standard home loan borrowers. It also called out how renters had to pay much higher than the market average when purchasing the property.
Furthermore, the legislative amendments contained provisions that allowed renters who had been signed up to these schemes previously to apply to the Victorian Civil & Administrative Tribunal (VCAT) to have their agreements terminated and recover their payments.
South Australia
In South Australia, the South Australian Housing Authority (SAHA) is the only authority that can legally offer rent to buy contracts. In addition, it has also cautioned people against entering into agreements with other bodies as the contract may not be legally binding in South Australia.
Modified rent to buy scheme
Since the ban on conventional rent to buy homes, a few new players have entered the market with a slightly modified version of the scheme.
However, since each has its own criteria, you should thoroughly check the fine print and get independent legal advice before signing the dotted line.
In addition, you must also ascertain that the rent agreed-upon and purchase price in future are reasonable compared to similar homes in the area.
How to Get Into a Rent to Buy Scheme?
This step-by-step explanation illustrates how you can get into a rent to buy scheme:
1. Find a Home That Suits Your Requirements
To begin with, since there are usually very few homes on the Aussie market offering rent to buy schemes, the process may be a bit challenging. You’ll need to do some amount of your own research online to find a suitable property.
Another option would be to find a regular home you can rent and negotiate with the owner if you move on to buy the house eventually.
2. Do Your Own Research About the Property
Once you’ve shortlisted your property, like any regular home buyer, do the basic checks, i.e., the property’s current price, the potential increase in property value, the average rent in the area, and the property’s condition in general. Finally, see if it’s in a safe and friendly neighbourhood that you’d like to call your own home one day.
3. Confirm the Credibility And Financial Situation of the Owner
A rent to own agreement with the home’s owner can have far-reaching consequences. For example, you could lose your purchase rights if the homeowner’s assets are seized and all that you’ve paid so far. On the other hand, in many instances where the renter has failed to pay rent regularly, the scheme owners have ended the contract and kept all previous payments made by the renter.
4. Seek Advice From an Independent Solicitor
Have an independent solicitor approve your rent to own agreement. As stated above, depending on the caveat, the lease may be terminated if you cannot make or miss a rental payment, and you could lose all the money you’ve already paid for the home.
Taking independent advice from a solicitor well-versed with rent to buy schemes can protect your interests.
5. Sign a Rental Agreement and Pay Your Rent
Once you get the go-ahead on the agreement, you have to submit your rental application stating your rent to own plan. You will have to pay the standard costs of renting a home and the non-refundable security deposit and get all the necessary approvals.
Be sure to pay rent on time. Even missing a rent payment may dissolve the agreement with rent to buy schemes, leaving you in debt.
6. Purchase the Rent to Own House
Most agreements are for three to five years before purchasing the house. At the end of this term, you have the option to purchase the house at the agreed-upon price, minus the deposit and fees you paid while renting. You will also need a home loan to help you pay the balance amount
Example of Rent to Buy Scheme
Consider the example of Dave, who enters into a rent to own agreement for 3 years, with an agreed future price of $500,000. He pays the deposit amount of $30,000.
Dave’s landlord charges him $700 rent a week, and an additional $100 a week as an ‘option fee’ so he can buy the property at the end of the agreed term if he chooses to. Thus, Dave pays his landlord $124,800 over the three-year lease period.
Dave’s contract specifies that the ‘option’ will go towards equity in his house, at the end of the lease period. Therefore, Dave would need a $454,400 home loan at the end of the rental term to make the purchase ($500,000 minus the $30,000 deposit and equity of $15,600).
Thus, although Dave’s landlord valued the house at $500,000, it finally cost him $609,200 ($500,000 plus $109,200 rent) at the time of purchase.
What are the Advantages of Rent to Own?
Rent to buy schemes allow tenants first to rent the property they would like to ultimately buy while waiting until the rental period is over to secure financing. This helps many aspiring home owners, especially first-time buyers, to enter the property market.
In addition, the other benefits include:
- Protection against price increase: As the property purchase price is set at the signing of the agreement, you are relatively insulated from rises in real estate prices later. This means you can plan and save the deposit amount and start looking for a suitable credit provider. On the other hand, prices are often inflated with rent to buy scheme.
- Build equity: You may sometimes be able to start paying off the primary balance as a percentage of your monthly rent and build equity in the home. This will help reduce your Loan to Value Ratio and, consequently, your loan amount.
What are the Disadvantages of Rent to Own?
The are significant risks associated with rent to own schemes for which they’ve been banned in Victoria and South Australia. Here are the top disadvantages of rent to own homes:
- No legal claim: Until you have successfully purchased the property, you have no legal claim to it as a renter. This includes getting approved for a home loan and ensuring you’re up to date with all rental payments and additional fees for the agreed rental period.
- Inflated Prices: Your monthly payments witness a huge spike -often around 50%-100% - with the cost of rent, additional “option-to-buy” fees and other charges. Moreover, based on your agreement, you may be responsible for the property repairs and maintenance, which will increase your expenses again.
- Non-refundable: Depending on the agreement, if you miss a payment, you could very well lose the property and whatever you’ve paid to go towards purchasing the home.
- Landlord-related risks: If your landlord or seller’s assets are seized due to defaulting on repayments, you (the renter) will not be able to purchase the house. You would have to forego all the payments you made.
- Lending criteria risks: If you do not meet the lending criteria and are not approved for a home loan, you cannot purchase the house. In this case, you will lose whatever money you had put in as a deposit.
- Property value: If there’s a drop in your property value, you’ll still be required to pay the purchase price that was set earlier. This could impact your financial situation.
Alternative Options
While rent to buy schemes offer Australians space on the property ladder, their risks could leave you with more problems. Considering these choices could be a safer way to own your dream home:
- Low-doc loans: This option is ideal if you cannot prove your income or provide the required documents needed to qualify for a loan.
- Low-deposit home loans: As the name suggests, you can access this home finance option if you have a small deposit.
- Bad credit home loans – Some specialist lenders will even offer you loans tailored around your bad credit.
- First Home Buyer Grants: While the housing market seems more unaffordable than ever, the first home buyer grants and other incentives by the government can help you get into your first home sooner. Read all about First Home Buyer Grants 2022 here!
Is Rent to Buy a Good Idea?
Keep these points in mind if you’re actively considering rent to own scheme to avoid any bumps down the road and understand whether the scheme is a good fit for you:
- The rent: Check if the rent costs are reasonable and at par with the market trends. If you have to pay above the market average, ensure that the contract specifies this extra money will pay off the home.
- Financial obligations: You should be able to afford the rent and the option fee. A rent to buy home means an additional 50%-100% on your weekly rent. You could lose everything saved towards your deposit if things don’t work as planned.
- Seller’s reputation: Victoria and South have outright opposed rent to buy schemes because they are very risky. Therefore run a few background checks on the specific project, read online reviews online and check if there’s any negative news about the scheme you’re looking at.
- Change of plans: At the onset, seek clarity and written confirmation about what happens if you eventually decide not to purchase the home. Ask if you will get a refund for the extra rent, etc.
- Home loan eligibility: Even if you pay your rent and option fees regularly, assess if you will be able to will get a loan to buy the house at the end of the rental period. If not, you may not get back any payments made.
Enter the Property Market with Joust
There are many decisions to make when looking to buy a new house. Joust can make the process easier for you.
Whether it’s to determine your budget, borrowing power, repayment schedules, comparing loans, etc., we’re here to help you make informed decisions. Check our user-friendly online Mortgage Calculators to indicate what you can afford and the best way to go about it.
Alternatively, head to our free-of-charge Instant Match service. Joust Instant Match is an innovative technology that saves your time and effort by providing suitable home loan lenders to your fingertips. For more information, head to our Instant Match product!
