Rent-to-buy schemes: How do they work and what are the pros and cons?

Rent to buy schemes, also known as rent to own schemes, are programs aimed at people who wish to purchase a home but may not have the capital to do so. They are sometimes portrayed as an alternative to the traditional method of saving for a deposit to purchase a property, and an alternative entry point to the housing market.

If you are considering rent to buy as a potential path to home ownership, though, it is important to understand the potential risks involved. It is important to be aware of the fact that rent to buy schemes can end up being very expensive due to fees and charges, and that the purchase of a property is not a guaranteed outcome.

What is rent to own?

A rent to buy scheme is a lease agreement that gives a tenant the option to purchase a property once their lease is over for an agreed-upon price. While living in the property, you will pay rent, along with other fees such as ‘option to buy’ fees. Unlike a normal rental arrangement, though, your rent payments will go towards building your equity, giving you a financial stake in the home.

Once the rental contract ends, then you will have the option to purchase the property and become the owner. That said, this option does not mean you are guaranteed to be able to purchase the property, as you will still need to arrange finance, typically by applying to a traditional bank or lender.

It is also important to understand that rent to buy schemes operate differently around Australia. Rent to buy schemes are banned in Victoria; while in South Australia, rent to buy options can only be offered by the South Australian Housing Authority (SAHA).

How does rent to own work?

While the actual process of entering into a rent to own scheme may differ based on individual circumstances, there are generally several steps that you might expect in the process. These are:

1. Choosing the house and deciding on your purchase price: After deciding upon the property you wish to purchase using a rent to own arrangement, you and the seller will typically agree on a purchase price for the house, and discuss the deposit amount and the amount of rent to be paid, as well as any fees.
2. Signing your rental agreement: After choosing a property and setting the purchase price, the next step will typically be to sign on as a tenant for a specified period of time, after which you will have the option to buy.
3. Paying your deposit: Though they are promoted as an alternative to the traditional home buying method, rent to own schemes will typically still require you to pay a deposit, which may be around 1-3% of the agreed-upon purchase price, and may or may not count towards your equity in the home.
4. Paying your rent: Over the course of your lease agreement, you will pay your rent at agreed-upon intervals. This rent may well be more expensive than market rates due to the fact that fees such as ‘option to buy’ fees are a built-in component..
5. Concluding the rental contract: At the end of a rent to buy period, you will have the option to purchase the property for the previously agreed-upon price; the equity you’ve built up in the property via your rent payments will effectively act as your deposit when you apply for a home loan.
6. Exercising your option to buy: If you still wish to purchase the property at the end of your rental agreement, you will need to seek finance through a traditional bank or lender, and take out a home loan.
7. Paying off your mortgage: Once your application for finance is approved, title in the property will be transferred to you, and you will continue paying it off via regular mortgage repayments to your bank or lender.

What does rent to own cost?

There is no set cost for a rent to buy and own a home, as it will depend on the property you’re purchasing. However, it is important to have a general idea of the costs involved, as these a likely to involve:

• A deposit: When entering a rent to buy agreement, it is likely that you will need to pay a deposit of around 1-3% of the agreed upon purchase price of the property.
• Ongoing fees: Your rent payments in a rent to buy property will include fees such as ‘option to buy’ fees as a built-in component, which can make your payments significantly more expensive than standard rent.

What are the pros and cons of rent to own?

If you are considering entering into a rent to buy and own arrangement, then it might be worthwhile to carefully consider all the potential benefits and drawbacks, to ensure you’re making a sound financial decision.

Potential pros of rent to own schemes

• An opportunity to build your equity in a property: Rather than a traditional rental arrangement, which sees your rent go to your landlord, a rent to buy and own scheme allows your rent payments to count towards your own equity, which can be used as a deposit when it comes time to purchase the home in question.
• Certainty as to price: In a rent to buy and own arrangement, the purchase price of the property will be agreed upon ahead of time, allowing you a degree of certainty as you plan and save for the eventual purchase.

Potential cons of rent to own schemes

• High rent payments: The fact that fees are a built in component of your rent in one of these schemes means that your rental payments are likely to be well above market rate, which could contribute to financial pressure.
• Potential to lose the property: When entering into a rent to buy to own scheme, it pays to read your contract carefully, as even one missed repayment could see you forfeiting the house, and whatever you’ve already paid.
• No guaranteed right to purchase: When it comes to the end of a rent to buy and own contract, you will likely need to borrow funds from a bank or lender to make your purchase of the home, and if you don’t meet their criteria, you may find yourself unable to buy.
• Landlord related risks: While renting a property, you will not have a legal ownership in it, and if the property owner is required to forfeit or sell the property, you may have little legal recourse, and may be forced to forfeit the money you’ve already paid.
• Potential for inflated price: When you sign on to a rent to buy and own scheme, the purchase price of your property will be agreed on ahead of time, and will be up to the seller to decide. The seller may inflate the price of the property, with the rationale that it may be worth more than its current value when it comes time for you to buy. This in turn could make your rental repayments more expensive.
• Potential for property value to go down: If you sign on to a rent to buy and own scheme and the property experiences a decline in value, you will still be required to stick to the original sale price when it comes time to purchase, even if the house is now worth less.
• Lack of consumer protection: The factors mentioned above all highlight the fact that rent to own schemes do not offer the same level of consumer protection that standard home loan borrowers are afforded by law.

Why is rent to own banned in Victoria?

Rent to buy, also known as rent to own schemes were banned in Victoria in 2020, with the state government saying that the move was an attempt to protect vulnerable would-be home buyers. Then-Consumer Affairs minister Marlene Kairouz said that the ban was also an attempt to crack down on potentially unscrupulous sellers..

“Whether it’s putting a stop to so-called rent to buy schemes or restricting the terms of contracts for residential property, we’re stamping out the ripping off and exploitation of families by greedy parts of the financial services sector and dodgy developers,” Kairouz said when the legislation was originally proposed.

At the time, the Victorian government said that any future rent to own schemes in the state would require official oversight and would need to be regulated by the Director of Housing or a similar housing body.

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