Right now in the Comox Valley, it’s really challenging to find decent rental housing and it’s also tough to get into the market for aspiring First Time buyers. In these challenging times, people look for any sort of in-road or advantage to help and one topic that comes up more often is the rent-to-own contract.

The idea behind a rent-to-own contract is that as the tenants/buyers, you enter into a contract with the landlord/seller to rent the property for a certain period of time while you pay both rent and extra money that accumulates to become a down payment.

For example, you could have a 3 year contract to purchase the property for $500,000 and be paying $4,500/month – $1,500/month is rent and $3,000/month is down payment contribution. At the end of the contract term (36 months), the down payment portion of your payments will be $108,000. To complete the purchase, you would need to qualify for a mortgage of $392,000 to make up the remainder of the purchase price.

Technically, Rent-to-Own contracts are legal in BC. However, in order to qualify for the mortgage financing to complete your purchase at the end of the contract term, you have to be very careful to set up your Rent-to-Own agreement properly at the beginning so that lenders will be able to approve your mortgage at the end.

The reason it gets complicated is because there are rules set up by the federal government that all lenders have to follow when it comes to tracking money used towards the purchase of real estate. Lenders have to verify the source of ‘down payment’ money to meet criteria for anti-terrorism and money laundering laws as well as rules set by the Office of the Superintendent of Financial Institutions (OSFI) meant to regulate mortgage borrowing and prevent unreasonable debt levels.

Part of standard mortgage qualification involves the lender reviewing the sources of all the down payment funds being used towards a purchase – looking over bank statements for money coming from savings or investments, receiving gift letters to confirm money being given from family, or auditing the sales contracts or receipts from asset sales where an item is sold (property, vehicle, etc) so the proceeds can be used towards a purchase.

In the case of a Rent-to-Own contract though, the down payment funds will not be in the possession of the buyer anymore – they will have slowly been paid to the landlord/seller over a long period of time. So for the lender to confirm the source of the down payment and meet government rules, you need to have complete records in place to confirm the Rent-to-Own contract and the accounting records to back it up.

Your records will have to support the following criteria:

  • That it was clear from the start that you were entering into a Rent-to-Own contract
  • That you were paying both a specific amount for rent and a specific amount for down payment contribution
  • That the rental amount was reasonable for the property and your area
  • That the excess money paid each month (towards down payment) was truly being treated as down payment funds towards the purchase

To meet the above requirements, you will want to work with a lawyer or notary to draw up the Rent-to-Own contract and make sure it clearly indicates the purchase price, the amount of down payment contribution each month, and details reasonable terms and conditions (for example, it should address how to handle missed or delayed payments, responsibility for maintenance of the property during the term, how the purchase price might change due to property damage or neglect, how the contract might be canceled by either party and the compensation or fee that would be due to the other party for cancellation, etc).

We recommend each party receive Independent Legal Advice before signing the contract to better ensure it is complete and fair to all parties and will stand up in court.

As well, the Rent-to-Own contract should be registered against the title of the property. This further confirms the intent of all parties, and provides security to the tenants/buyers by preventing the landlord/seller from being able to sell the property to another party without notice and consent of the tenants/buyers.

Beyond the contract itself, we also recommend having an appraiser draw up a Letter of Economic Rents for the property, which will confirm how much rent is reasonable. This acts as supporting evidence that the amounts you pay monthly over and above the rental rate indicated by the appraiser are contributions towards the down payment.

And last but not least, the landlord must maintain proper accounting records and accumulate the down payment funds in a separate bank account over the course of the contract. This ensures the landlord/seller can provide clear records of the down payment funds being accumulated, and it also ensures the down payment funds are available to be refunded if the sale does not complete.

In total, you should expect to pay about $2,000 to set up a Rent-to-Own contract ($500 for the appraisal, $1,500 for legal fees).

With the right contract, the letter of economic rents, and proper accounting records from the landlord, a lender can confirm the down payment source and you can successfully get approved for a mortgage to complete your purchase. But as you can see, it’s important to get all these pieces in place before you start paying any down payment money. Otherwise, you risk going for years paying extra money to your landlord and then at the end not being able to complete your purchase and potentially losing it all.

The other big factor to consider in a rent-to-own situation is that your contract (drawn up at the beginning of the arrangement) will specify the purchase price for the property that you will eventually pay at completion.  This is the same as any other real estate purchase contract, except in the case of a rent-to-own scenario the closing date might be several years in the future. From a mortgage perspective, the lender will calculate your maximum mortgage amount from the lower of either the purchase price (in the contract) or the current market value at closing (as determined by an appraisal).  So there are 3 possibilities to be prepared for:

  1. Property prices increase over the time you are renting: this works to the advantage of the buyers, since at closing they will buy the property for a price lower than the current market value. There is no negative impact in qualifying for mortgage financing.
  2. Property prices stay flat over the time you are renting: this is a neutral outcome for both the buyer and seller. Since the purchase price at the time of closing is the same as the market value, there is no negative impact on mortgage qualification.
  3. Property prices decrease over the time you are renting: this works to the advantage of the sellers, since they will get a better sale price than they would otherwise by listing the property to sell to another party. For the buyers, there is also an added complication because the mortgage lender will use the lower current market value to determine the maximum mortgage.  For example, let’s assume the contract purchase price is $500,000 and the buyers have accumulated a down payment of $100,000 (20% of the purchase price) through their rent-to-own payments over 3 years. To close the purchase at the end of their contract, they were planning to receive a mortgage of 80% of the purchase price, which is $400,000. However, if over the 3 year contract the market value of the property falls to $450,000, then the lender will calculate the maximum mortgage as 80% of $450,000, which is $360,000.  In order to complete the purchase, the buyers would need to raise an additional $40,000 from their own resources (personal savings, gift from family, sale of an asset, etc) in order to complete the purchase.  As you can imagine, for most people this would be a significant challenge if it comes up unexpectedly right at the time of closing, so for rent-to-own contracts that have long timelines, we recommend buyers keep informed about the local real estate market and be proactive about saving some additional funds to cover an unexpected shortfall.

Before you get started with a rent-to-own contract, we strongly recommend that you speak with us and get pre-approved for the eventual purchase. You want to know what will be required for your eventual mortgage qualification (how much income you’ll need at the time of purchase, how much down payment will be required, how to protect your credit to ensure you’ll qualify, etc) so you can keep yourself on track during the rental period and arrive at the purchase date fully prepared.Other resources: The BC Financial Services Authority has an article on Rent-to-Own contracts.