The 9 Rent-to-Own Risks Nobody Likes Talking About
Copyright © rent-to-own Match Makers www.RentToOwnMatchMakers.com Email:
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Copyright © rent-to-own Match Makers www.RentToOwnMatchMakers.com Email:
[email protected]
Introduction Rent-to-Own home ownership is an alternative lending solution for home buyers that are unable to qualify for a traditional mortgage. It is meant to be a winning strategy for everyone involved. This includes the mortgage agent, the home buyer, realtors, the Rent-to-Own company, and the sponsoring investor. With the help of a sponsor, a home buyer who is unable to qualify for a mortgage the traditional way can get into a home of their choice in as little as 6 weeks. The sponsor has a pre-qualified buyer living in the home from day one, so this strategy creates a “win-win” for both of you since they do not need a realtor when the time comes to sell you the home. Every Rent-to-Own solution provider is quick to talk up the benefits of this strategy, but they usually don’t like talking about the risks involved with it. The risks are real and since they have the greatest impact on you, the tenant-buyer, it’s an important conversation to have. In this short report you’ll learn how you can protect yourself from unethical Rent-to-Own companies that really don’t care whether you succeed in buying the home or not. These “Scorpion” companies (because those victimized by them are left feeling the financial sting for a long time) prey on uninformed home buyers desperate for a solution and someone to help them. There will always be bad apples in every industry that only look out for themselves. The Rent-to-Own industry is no different. The opportunity to profit from helping someone in peril also presents an opportunity for abuse that’s difficult to prevent. Whether the abuse is intentional or the result of incompetence, the negative stigma that follows makes it more difficult for the serious professionals to help people like YOU achieve their goal of home ownership. We’ll share the 9 common risks used by unethical companies in the Rent-to-Own industry to take advantage of the uneducated consumer, and what to do about it. By reading this brief report you’ll understand exactly what to watch for in choosing a Rent-to-Own provider that is dedicated to helping you succeed in eventually buying your home and making this solution a win-win for you too.
The 9 Rent-to-Own Risks There are many unethical Rent-to-Own providers who take advantage of home buyers by ignoring or leveraging one or more of the following risks. Be warned that if you fail to recognize any of these risks, you will also likely fail to buy the home and end up losing your deposit and option credits.
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The 9 risks that unethical Rent-to-Own providers don’t like to talk about are: 1. 2. 3. 4. 5. 6. 7. 8. 9.
Optimistic Budgeting Accelerated Rent-to-Own Terms Inflated Option Prices Defective Homes…Buyer Beware! Failing to Understand Agreements Down Payment Deficiencies Market Cycles Poor Credit Change in Sponsor’s Circumstances
Failing to recognize any of these risks can be a serious setback in your goal of home ownership. By avoiding these pitfalls and working with the right company, Rent-to-Own solutions have helped many families to succeed financially - it will help yours too.
Risk #1 – Optimistic Budgeting The number one risk to be aware of when buying your home is overextending yourself financially. Whether you are obtaining a traditional mortgage, working with a private lender, or purchasing using a Rent-to-Own program, it is very important that you stay within your budget. The primary reason for failure in home ownership, regardless of the lending product, is a default by the home owner. Scorpion companies know this and use it as a way to steal your down payment. Instead of encouraging you to stay within your budget, unethical companies will try to convince you to purchase a home you cannot afford knowing that you won’t be able to afford the payments. When this occurs it gives them the ability to take your deposit. Here are 2 guidelines from CMHC (Canada Mortgage & Housing Corporation) on affordability:
Affordability Rule 1 The first rule is that your monthly housing costs shouldn't be more than 32% of your gross monthly income. Housing costs include your monthly mortgage payments (principal and interest), property taxes and heating expenses. This is known as PITH for short — Principal, Interest, Taxes and Heating. Lenders add up your housing costs and figure out what percentage they are of your gross monthly income. This figure is called your Gross Debt Service (GDS) ratio. To be considered for a mortgage, your GDS must be 32% or less of your gross household monthly income.
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Affordability Rule 2 The second rule is that your entire monthly debt load should not be more than 40% of your gross monthly income. Your entire monthly debt load includes your housing costs (PITH) plus all your other debt payments (car loans or leases, credit card payments, lines of credit payments, etc.). This figure is called your Total Debt Service (TDS) ratio. Source: CMHC (Canada Mortgage and Housing Corporation) - http://www.cmhc-schl.gc.ca/en/co/buho/hostst/hostst_002.cfm
We recommend that you stick to these guidelines regardless of whether you are financing your home purchase with a mortgage, private lender or Rent-to-Own program. If anyone tries talking you into stretching beyond your budget and ignoring these guidelines, then red light - this is warning sign #1. An optimistic budget is an inflexible one, with little room for variability, and limited or no contingencies to account for the unexpected. This type of budget requires that everything go according to plan, may be dependent upon future events materializing that are beyond your control, or even limiting your means to afford it. There is another word used to describe this – unrealistic. Your budget must be realistic at minimum and include consideration of only your present circumstances and lifestyle. Stretching yourself thin is better suited for Yoga, not your finances. Ideally you should consider a pessimistic budget which accounts for unexpected life events that could impact your finances and the ability to afford a rent-to-own (like unemployment, an accident, or death in the family). Then develop a plan that addresses these scenarios. We suggest choosing a life insurance product to help offset and mitigate some of the risks.
Risk #2 – Accelerated Rent-to-Own Terms Another common risk that buyers often fall victim to is entering a Rent-to-Own program where the term is too short. While “instant gratification” may be a characteristic of our society, time is your ally in overcoming whatever obstacles are preventing you from getting a mortgage today. Bottom line…it will require some time, and patience, to fix any issues on your credit report, accumulate a larger down payment, and build a strong track record of income or employment stability. Some irresponsible companies will encourage you to enter a 1 or 2 year Rent-to-Own program knowing that it will take you longer than that to qualify for a mortgage. They also know that it may be difficult for you to manage the higher monthly payments that usually come with a shorter term since you must still save a minimum down payment, but in a shorter amount of time. The 9 Rent‐to‐Own Risks Nobody Likes Talking About
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Sound familiar? It should because it leaves you exposed to the same risk we explained with optimistic budgeting. Again, this is just another way for them to collect your deposit and patiently wait for you to fail. To manage this risk, be realistic about how long it will take for you to qualify for a mortgage. Start by ensuring your Rent-to-Own term positions you to succeed by allowing you enough time to qualify. We suggest using the third rule in our Rule of 3s - 3 year term. A three year Rent-to-Own term is a common feature for most families since it typically offers the most manageable monthly payments. Before entering a Rent-to-Own program we also recommend consulting with a mortgage broker or credit repair specialist to get a better understanding of your current situation and confirm how much time you’ll likely need.
Risk #3 – Inflated Option Price Overinflated option prices are one of the easiest tactics for Scorpion companies to deploy against uneducated buyers. Don’t let yourself fall into this trap. High option prices are achieved in 2 ways: 1. Starting with an inflated purchase price 2. Using an aggressive appreciation rate Most Rent-to-Own providers will start off with the market value for your home, and then add appreciation to the home at a fixed rate (say 4% per year) to calculate your option price. This option price is what you will pay for the property at the end of your term. However if the starting price is too high, or they apply an overly aggressive appreciation rate to that price, your option price will end up being too high which creates a new set of obstacles. If the home does not appraise for close to what your option price is at the end of your Rent-to-Own term, you’ll have trouble getting the mortgage needed to buy the home once you exercise your option. If you do not buy the home then you could also lose your deposit and accumulated option credits. You can avoid this risk by using the first rule in our Rule of 3s - 3 X your Gross Household Income = the Current Market Value. This is a quick and conservative calculation to ensure that your sponsor is buying a home that you will be able to afford. This value is your budget limit. You should also enlist the services of a realtor to help you understand the value of homes in the area where you are buying, and what the historical price trends look like. A Realtor can show you the values of comparable home sales and give you more information on appreciation rates in the area. Remember! Never agree to an option price that begins with an inflated market price or is calculated using an aggressive appreciation rate.
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Risk #4 – Defective Homes …Buyer Beware! There are two approaches typically used in creating a Rent-to-Own transaction that every buyer should understand. 1. The first approach is known as “tenant-first” Rent-to-Own. This method allows you to select a home of your choice as any traditional buyer world. 2. The second approach involves selecting a home from an investor or company’s existing inventory. This method is called a “property-first” Rent-to-Own. In a tenant-first Rent-to-Own scenario you have a wider selection to choose from, with the only limitation being your budget. Under this approach you’ll usually work with a Realtor to choose a home, and go through the same offer process, home inspection and closing period as a regular buyer who is approved for a traditional mortgage. The property-first Rent-to-Own requires the buyer to choose a home which an investor or company already owns. The main advantage here is that it enables you to get into your new home immediately. There are however two potential issues that a buyer should be aware of. The first issue arises when a Rent-to-Own provider is influenced solely by profit or avoiding further losses. Their primary motivation may be leasing-up a property that has been vacant for some time or has been difficult to sell. As a result you may be confronted by hard sales and pressure tactics which only serve to increase the likelihood of the previous three risks becoming a factor. Of greater concern is the increased probability of ending up with a problematic home. In a property-first Rent-to-Own, there usually isn’t a home inspection available since the property is already owned. Therefore there is no way to know exactly what you’re buying. To reduce this risk we suggest having any home you wish to purchase inspected by a professional home inspector. Notice we said reduce the risk. The truth is that a home inspection does not eliminate the possibility of buying a defective home. As with any traditional home purchase the old mantra remains true – Buyer Beware! Many tenant-first Rent-to-Own companies require that you pay for the cost of this home inspection (usually $300-$400), but it is better to know exactly what you’re investing your hard earned money into before you commit thousands of dollars to buying a home by signing a cheque. Should you decide to work with a property-first Rent-to-Own company then you must insist on getting a professional home inspection completed so you can be sure the home is sound. If you encounter any resistance remember that you’re the one paying for the inspection, so you must ask yourself “what are they hiding?” Be prepared to walk away otherwise it could be an expensive lesson.
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Risk #5 – Failing to Understand Agreements The risk of not understanding agreements is a critical one mainly because it includes three hidden risks. The risk surrounding Rent-to-Own agreements comes with simply not recognizing the elements which present the greatest risk to your ability to succeed in buying the home. If you don’t recognize the risks present in how a Rent-to-own is structured, the disappointment of not qualifying for a traditional mortgage today will come full circle when you’re unable to qualify for a mortgage to buy your home at the end of your lease term. Every Rent-to-Own provider loves to talk about the long list of benefits in this strategy, but they usually won’t go out of their way to point out the many risks involved. If they are unable to have a blunt conversation about the risks, or offer solutions to addressing them, this may be sufficient reason to doubt their integrity. It is important to trust your instincts. Once you have an explanation from their point of view, you should seek independent legal advice to confirm what you’ve been told and identify any discrepancies. These discrepancies are not limited to what may have been said. The impressions you received are equally important to confirm and clarify. It is important to remember that when you seek legal advice it is not to rewrite the contract. That said a lawyer may attempt to do just that. This is fine since they would prefer the agreement be in your favour. It is their duty to keep you from entering into what they think may be a bad deal. It’s what lawyers do. It also isn’t necessary, can become very expensive, but worst of all, it may convince your sponsor that you’re not an easy buyer to work with. Remember this: Your sponsor is investing a lot of money to buy the home on behalf of someone they do not know and risking their personal credit in the process. They deserve to be protected from any damages that might arise should the arrangement not unfold as intended. Otherwise there wouldn’t be Rent-to-Own solutions available to you as an alternative. For most people, buying a home represents the largest purchase and most significant asset they will ever own. With that in mind, it is important to be sure you understand any agreements you sign with a Realtor, mortgage lender, or Rent-to-Own provider. While agreements vary from one company to the next, the next three risks represent the critical components of most Rent-to-Own contracts.
Risk #6 – Down Payment Deficiencies When a buyer decides it’s time to save a down payment to purchase a home they either fulfill that commitment or they don’t. The timeline for buying a home is typically flexible and there is no real consequence if they don’t since the sole responsibility for saving the down payment rests with the buyer. The 9 Rent‐to‐Own Risks Nobody Likes Talking About
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This isn’t usually the case in a rent-to-own. The Rent-to-Own buyer must have a minimum down payment saved within a specified amount of time. Under the terms of a Rent-to-Own agreement a specified amount is set aside every month as part of a forced savings plan. This amount is eventually credited or rebated to the buyer when they purchase the home from their sponsor. A forced savings plan is an important feature of a Rent-to-Own program since you could lose your deposit and option credits if you are unable to qualify for a mortgage. For this reason it is critical that the Rent-to-Own company properly accounts for this when preparing your success plan. There are three factors that will impact your ability to have enough saved for a down payment to succeed in a Rent-to-Own program. They are: 1. Providing no, or very little, deposit up front 2. Not saving enough each month during the lease term 3. Late payments An upfront deposit represents the foundation of your eventual down payment to buy the home. When a Rent-to-Own company does not require a reasonable deposit they are placing the entire responsibility for saving an adequate down payment on the buyer. They are also positioning you to fail. The money for the down payment must come from somewhere. If you don’t have a reasonable deposit when you begin the only other place to account for it is through a higher lease payment and more option credits. For most families a rent-to-own is already an expensive alternative without having higher monthly payments. The next factor which will impact your down payment is whether you are given enough option credits each month to build a sufficient down payment. This requires that the Rent-to-Own company first develop a plan that specifically outlines how much you will need to save and then determine the monthly credits required to reach this. The size of the down payment may affect whether or not you are approved for a mortgage. Canadian buyers for instance must have a minimum down payment of 5% to qualify for mandatory mortgage insurance on high loan-to-value mortgages. Closing costs must also be considered which raises the minimum a buyer will need to have saved to approximately 7%. We suggest using the second rule in our Rule of 3s – 3% minimum deposit. You calculate this by multiplying your budget price – or 3 X your Gross Household Income (the first rule in our Rule of 3s) – by 3%. This is only a minimum deposit. More is common and is always better, especially where a cheaper home is chosen to feel comfortable with the monthly payments.
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Late or missed payments are the last factor which will detrimentally affect your ability to save a large enough down payment. A late payment may result in you losing the option credits for that month. Should this occur two or three times a year then you may you not have enough saved for a down payment. If you are unable to qualify for a mortgage to buy the home as a result then you risk losing your deposit and accumulated option credits.
Risk #7 – Market Cycles Markets move in cycles that are influenced by factors beyond our control. The real estate market is no exception. Interest Rates, mortgage qualification rules, inflation, employment levels, and the economy all affect real estate markets - and ultimately prices. This is a very important consideration in a Rent-toOwn transaction. If the price of your home does not appreciate as expected you could end up with an inflated option price (see Risk #3). The result is that you may have trouble getting approved for the mortgage you need if the appraisal does not come back close to your option price. As a general rule you will want to consult different sources to determine the appreciation rates in an area for yourself. Real estate markets are localized so your best source will be found in neighbourhood specific information provided by a realtor in the area you plan on living.
Risk #8 – Poor Credit One attractive feature of the Rent-to-Own solution is the time it allows a buyer to repair their credit before applying for another mortgage. Time is essential to being able to repair your credit, especially after a bankruptcy or consumer proposal. This is the primary reason why accelerated Rent-to-Own terms are destined to fail when credit repair is also required (see Risk #2). If you are still unable to qualify for mortgage financing to buy the home at the end of your Rent-to-Own term you again risk losing your down payment and any accumulated option credits. It is important that the success plan a Rent-to-Own company creates for you not only includes credit repair, but makes it a mandatory prerequisite for acceptance into their program when a bankruptcy or consumer proposal is involved. Credit repair is a time consuming process that involves many variables. This makes it difficult to predict how quickly your credit will improve and which items will ultimately be removed. Yes, credit repair will cost extra, but it will likely cost much more in the long run if you are unable to qualify for a mortgage at the end of your lease term. A simple solution to protecting your down payment is to ensure that the Rent-to-Own agreement includes
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a monthly or yearly roll-over. While your purchase price may increase, this will provide you with extra time at the end of the term in the event you still can’t qualify.
Risk #9 – Change in Sponsor’s Circumstances All the above risks may be difficult to identify to an untrained buyer or casual observer. There is one final risk that remains and because it hides in plain sight it is often the most difficult to recognize – Your Sponsor. This may come as a surprise. After all, how can the same person that is here to help you, willing to invest their own money in you, and risk their personal credit for you, also be a risk? The answer is simple – they’re human too. And then there’s Murphy. When Murphy strikes it is almost always without warning. Remember that if anything can go wrong it will. Even for your sponsor. If they experience a significant life event such as divorce, bankruptcy, or death, then like it or not, there is the possibility of any one of these also affecting your Rent-to-Own program. There is also the possibility that a sponsor may not honour their end of the agreement. Either way, the truth is that litigation may be required in order to protect your option to purchase the home. Fortunately a Rent-to-Own Agreement that has previously been reviewed by your lawyer provides you with options in resolving your dispute, not the least of which is clouding title by registering your interest in the property for example. Many of the risks that we have discussed are not unique to Rent-to-Own solutions. Although they are similar to those you would encounter as a regular buyer seeking a traditional mortgage it is still important that you know that there are risks and understand them before diving into a Rent-to-Own program. A competent Rent-to-Own provider will not be afraid of talking about all of the risks in the program with you. They should also insist that you get independent legal advice before signing the agreements they give you. These are just two of the traits that you will want to look for in a Rent-to-own Provider
Selecting the Right Rent-to-Own Provider We have outlined a number of risks you should expect to encounter that could very well prevent a Rentto-own transaction from being the win-win strategy it is supposed to be. Choosing the right provider is a very important decision in ensuring that this alternative lending solution delivers the ultimate result for your family – being able to buy a home.
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Here are our top 10 suggestions in selecting the right company: 1. Select a company that will work within your budget while keeping your GDS ratio below 32%. Do not let a company stretch your budget. This is a red flag! 2. Remember our Rule of 3s - 3 X your Gross Household Income, 3% minimum deposit, 3 year term. 3. Rent-to-Own companies who are realistic with their lease terms usually have your best interests at heart. They must recognize the importance of time in overcoming the obstacles that prevented you from getting a mortgage and conservative in determining how much time is needed. 4. An experienced company should be able recommend a Rent-toOwn friendly Realtor who is able to verify a realistic option price based on historical appreciation rates your area. 5. Give preference to those companies that always require the completion of a home inspection as a routine part of their Rent-toOwn process. 6. Only work with those companies that insist upon you obtaining independent legal advice before signing any agreements. This is another red flag when you aren’t given an opportunity to do so. 7. Choose a Rent-to-Own provider which offers an in-house credit repair program. This is a clear indication of how seriously they regard your success, and ultimately their own. 8. Request testimonials from the Rent-to-Own company to verify that their clients are satisfied. Privacy laws may prevent them from disclosing client information but it never hurts to ask. 9. Ensure that their Rent-to-Own agreement has some flexibility by providing a roll-over term which allows extra time at the end of the term in the event you can’t qualify. 10. Trust your instincts. Remember these 10 tips when you’re entrusting a Rent-to-Own company to prepare your plan, secure your sponsor, and position you to prosper. Companies that meet these criteria will steer you around the scorpions who are more interested in profiting from your peril than they are in your financial success. By combining these tips with knowledge of the 9 risks we’ve just shared you are well equipped to make an intelligent decision when considering this alternative solution to home ownership. Take the first step towards becoming a home owner sooner by applying for our Home Ownership Purchasing Education (H.O.P.E) - Click Here and Apply today!
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