Rent to Own vs Traditional Mortgage

If you're already looking into owning your own home but can't qualify for a mortgage or haven't saved enough for a down payment, you still have an alternate path to homeownership.

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Rent-to-own programs are available to those who may not have the credentials needed to get approved for a traditional mortgage.

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So, how do rent-to-own arrangements work and how do they differ from traditional mortgages? Let's get into more detail about this program to see if it's something worth considering.

What Is A Traditional Mortgage? 

A mortgage is a type of loan that homebuyers use to finance the purchase of a home. The significant cost associated with buying real estate makes it nearly impossible for the average Canadian to come up with the funds needed to make an all-cash transaction. But with a mortgage, you can buy the home now and pay down the purchase price over time through regular installment payments. 

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You can choose how frequently you'd like to make your payments (monthly, bi-weekly, or weekly, for instance), and how long you'd like your amortization period to be, in Canada the most common is 25 years.

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When you apply for a mortgage, your lender will assess your financial and credit health. To get approved, you'll need a substantial and stable income, a good credit score, and manageable liabilities. If you are approved, your lender will use this information to determine the interest rate to offer you. This rate will make a big difference in the total amount you owe over the life of the loan. 

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What Is A Rent-To-Own Home? 

In a rent-to-own contract, you rent a home owned by another person or company for a specific amount of time with the intention to purchase at a specified date in the future. A portion of every rental payment you make goes toward saving for your future down payment. 

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With a rent-to-own home, you don't have to save up the traditional 5-20% down payment required for a mortgage in Canada and you won’t have to meet the stringent criteria of a conventional mortgage. But you'll still have the opportunity to live in your dream home today with the option to buy it back later at a guaranteed price.

1. Lower Down Payment

While you won’t need a hefty down payment, you might have to make an "initial deposit," which can vary but is typically around 2% of the purchase price of the home. 

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2. Lower Buy-back Home Price 

Once the lease ends and you're mortgage ready, you can buy the home at the initial agreed-up price which is computed at approximately 5% compounded annual rate. This is way lower as compared to the national annual house increase is around 20% year on year based on CREA. 

Pros And Cons of Rent-To-Own Homes 

There are a wide variety of reasons why a rent-to-own agreement is a great option for many consumers. But, as if any financial decision there are always factors that need to be considered more carefully. Let's go over them all to help you decide if this type of arrangement is right for you.

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Pros

• Become a homeowner. Ultimately, the biggest advantage of a rent-to-own is becoming a homeowner. Rent-to-own lets Canadian consumers purchase the home of their dreams even if they thought that dream was out of reach.

• Test-drive the home before you buy it.. Buying a home is a huge financial commitment, so it makes sense to take the time needed to ensure you are making the right purchasing decision. The great thing about renting-to-own is that you can live in the place for a few years before deciding to buy it or walk away with your savings.

• Time to save for a down payment. Rather than waiting years to save for a down payment without a home to show for it, you can start living in your home right away and save for your down payment while you're living in the home.

• Credit building. Mortgage approval requires that you have a healthy credit score. Instead of postponing a home purchase while you improve your credit score, you can work on that throughout your consistent monthly payments, as some rent-to-own company reports to credit bureaus.

• Locked-in future buy-back price. Even if home prices increase, you'll pay the locked-in purchase price that you agreed on when you first signed your contract. This means you could potentially pay less for your home than what you would normally pay in a traditional real estate transaction. 

Cons

• Locked-in future buy-back price. While locking in a purchase price might be a good thing if prices are higher at the end of your lease term, you may have committed to paying more than what the home may be worth when it's time to buy.

• Non-guaranteed mortgage approval. At the end of the lease term, you're required to get a mortgage to help finance the purchase of the home. If you don't work to improve your financial and credit profile during the rent-to-own lease period, you may not qualify for a mortgage needed to purchase the home. 

• Higher monthly payment. The monthly payment consists of rental fees and savings, it is typically higher than the usual mortgage.

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Should You Rent-To-Own A Home or Get A Traditional Mortgage?

Your specific life situation will determine which of the two arrangements may be best for you. 

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Why Consider A Mortgage?

You may want to consider a mortgage because when you rent-to-own, the owner of the property will use a portion of your rental payments to cover the mortgage. But if you had taken out a mortgage and bought the home from the get-go, then you would have already been a few years ahead in paying off your mortgage by the time the rent-to-own lease term ends. And during that time, you could have been building equity in the home, which represents your interest in the home that you own.

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Why Consider Rent-To-Own?

While purchasing a house the traditional way may be the right option for some and even the preferred option, rent-to-own is a good alternative if you're not currently in a position to get approved for a traditional mortgage or don’t have the savings need for either the down payment or closing costs. You should consider rent-to-own if:

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• You need help qualifying for a mortgage.
• Your poor credit score is stopping you.
• You need help saving for a down payment. 

Final Thoughts

While taking out a mortgage to finance a home purchase is the ideal way to become a homeowner, some homebuyers may not have the financial and credit strength to get approved. If you can't qualify for a traditional mortgage, a rent-to-own arrangement may be a great option for you to get into a new home sooner rather than later while you contribute to the home's purchase price and build good credit.