Buying a house or property on “Rent to Own” is a form of seller financing (or Vendor Finance) that’s popular as an alternative to Bank finance.
People who, for various reasons cannot qualify for a bank loan may still purchase a property without the bank. And if structured correctly, this form of lending has many additional benefits. Firstly the buyer will still need to have the ability to “service” the arrangement (make set payments) but there are less hurdles to jump in the application and qualifying stages.
While it’s a fact that banks don’t seem to favour lending to self employed business people, there are many stable buyers who cant get a bank loan. There are two common types of arrangements (instruments) seller’s can use to facilitate the sale of a property to a buyer who falls outside the bank’s lending criteria:
- Installment Loan
- Rent to Buy.
Installment loans are where the buyer enters into a contract to purchase and makes payments over a set number of years. Installment loans must be put together by an accredited person with a Credit Services Licence. There is most often a deposit required for purchase of property on an Installment Loan because legal title to the property is passed to the buyer once they have paid more than 10% of the purchase price. There is more perceived security for both parties to the deal since a standard contract of sale and some special clauses is used to create this arrangement. The objective for the seller who provides Vendor Finance, is to have the buyer refinance in 2,3,4 or 5 years when they have built up some equity and qualify for a bank loan. In the meantime, the seller takes a longer term view to getting their property sold and the buyer secures a property in the current market.
Rent to Buy
The second common type of arrangement is the ‘rent to buy’. Here the buyer gets to move straight into the property and live there until they decide they want to buy. Consider this a “try before you buy” type of arrangement and involves a rental agreement (residential tenancy agreement) for a predetermined period (years) based on the buyer’s affordability and calculated against the sale price of the property. The tenancy agreement is signed along side an option agreement. The option is in the Buyer’s favour, meaning that, they can activate the purchase any time before the option expires, which is usually 2-3 years. The buyer can also sell the property and take the profit if the market has risen since after they secured the Rent to Buy arrangement.
Rent paid by the buyer is worked out as an amount for the weekly rental plus an option fee. The two amounts total as the weekly repayment the buyer makes during the term. Often the seller will package the rent with rates and insurance charges, making the buyer responsible for typical ownership costs that go with owning the property. When the buyer decides to cash out by either selling the property (assigning the option) or applying for a bank loan and paying out the seller, they can potentially be in profit making territory due to the increase in property value, or benefit from reduced repayments from the bank loan that replaced the Vendor Finance arrangement.
Some of the benefits of the ‘rent to own’ or ‘rent to buy’ program are:
- Low risk with flexible ownership options
- Buyer can walk away and hand back the keys at any time
- Fixed payments and no interest fluctuations
- Legitimate alternative to bank loan
- Small deposit required – usually less than $20,000 or depending on the deal even $10,000
- Sometimes NO DEPOSIT, in exchange for higher repayments
Money Back Towards the Purchase
Often the buyer will receive rent credits or a reduced settlement amount if they have made their payments on time or if they sell or settle early during the Rent to Buy arrangement. This is not something Banks can provided with their lending, but for the buyer who doesn’t fit the bank lending criteria, Vendor Finance is a vehicle that provides the opportunity to own a home, using the seller as a form of agreeable partner in the process to assist the buyer into the market.
Who Arranges Vendor Finance?
In most cases, Vendor Finance arrangements are assisted or put together by individuals who are experienced with the creative mechanisms of such arrangements. It is important the circumstances of the seller are well considered to ensure their needs are met by the selling arrangement. The Vendor Finance expert (VF) acts as an intermediary and gets paid a predetermined portion of the rent or end value when the seller is paid for the property.
A Simple Example of How it Works
For example:
- The VF negotiates with the seller for the sale of the property at a price today of $300K.
- The Seller agrees to either sell or let the VF take control of the property for 2-3 yrs if they pay all the expenses and maintain the property. This may also include covering the loan repayments that the seller might also have remaining on the property.
- The VF then sources a buyer for $350K and transfers the opportunity to buy the property at $350K within a time frame of say 3 years.
- The VF takes a deposit upfront from the buyer and an ongoing option fee which is part of the total weekly rent paid by the buyer.
Continuing the example, if the weekly rent totals $490, it might be broken up as $350 paid to the seller for rent, $120 on the option fee to cover rates, insurance & water etc, and $20 to the VF for administration of the arrangement. The rental portion is usually the bit that includes additional loan repayments of the original owner.
These figures are examples only to illustrate how the Vendor Finance arrangement may work, however the amounts and circumstances can vary greatly depending on the property, location, parties involved and time frames.
As mentioned, there are so many variables to these arrangements, this is just a basic account of the workings. At the end of the day, the VF will structure a deal that works for the buyer, as long as they can afford the payments without undue hardship and appear genuine and responsible people. CLICK HERE for a summary of RENT TO OWN strategy.
What Happens During the Loan?
It is also general practice to credit part of the option fee or part of the rent back to the buyer at the end of the term so that they have sufficient deposit for bank finance plus costs to assist their ability to get a bank loan. If the buyer defaults on payments or hasn’t got the ability to cash out at the end of the term, in most cases they forfeit any credits off the purchase price and may be required to pay an additional option fee to extend their arrangement.
How Do I Get to Own the Property?
The advantage for a buyer is the opportunity to buy a property in today’s market at a price that’s reasonable. They wont be buying below market in most cases, but they may have 3 years of capital growth (hence increased equity) and accrued deductions in the form of credits from weekly rent that goes towards reducing the eventual purchase price. A property needing repairs ie, fixer upper, would allow the buyer to increase their equity even more by adding value to the property. This is one way a buyer can fast track ownership using the Vendor Finance vehicle. The service history with the VF is a valuable component of the arrangement as it can be used to support a bank application for finance when the buyer is ready to cash out and settle the property. The buyer could also sell the property at any time by assigning the option and keeping any increase between the selling price to their buy price. The buyer wont be able to use any equity during the course of the VF loan because the seller would have to give up legal title to the property to allow this to happen. The only way they could consider using the equity is to refinance with a bank, often the seller may take a second mortgage for the shortfall the buyer couldn’t get together for the bank. This would however increase the seller’s risk in the deal so should not be expected in all cases.
For buyers wishing to secure their own home now rather than some years down the track when prices have gone up further, it would be best to identify the exact area they want to be located in and seek out a VF expert in their area or contact PropertyResults.com.au today.