Rent to buy schemes, also known as rent to own schemes, are aimed at people who want to buy a home but don’t have the immediate funds to do so. While they might sound like an alternative to saving for a deposit while paying rent, they are incredibly risky, and are even banned in some parts of the country.
If you’re considering going down the rent to buy path, it’s important to be aware that these schemes tend to command higher-than-market rate rents, as well as expensive fees and charges, and you’re not guaranteed to walk away with a property.
What is rent to buy?
A rent to buy scheme starts with 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 and other fees, like ‘option to buy’ fees.
Unlike a normal rental arrangement, part of your rent payments will generally go towards building ‘equity’, seemingly giving you a financial stake in the home. Bear in mind, however, that the tenant usually doesn’t have a legal stake in the property at this point, meaning any ‘equity’ isn’t really yours until the purchase legally goes through.
Once the rental contract ends, you’ll likely have the option to purchase the property. That said, this isn’t guaranteed, as you’ll probably still need to arrange a home loan for the remaining purchase price. If you’re knocked back by a lender, you could be left with nothing.
Why are rent to buy schemes risky?
Consumer advocates have long warned against rent to own schemes. The Consumer Action Law Centre called for them to be banned in 2016, saying they primarily target lower-income earners who struggle to qualify for standard mortgages, while offering "grossly inadequate" legal protections.
Key risks associated with rent-to-buy schemes include:
- Inflated purchase prices: Sellers often lock in an above-market price under the assumption that property values will rise during the rental term. If prices don't rise as expected, you could end up paying over market value.
- Mortgage approval issues: When it comes time to buy, your home loan lender will conduct its own valuation. If it values the property lower than your agreed price, it may refuse to finance the mortgage, leaving you unable to complete the purchase.
- Risk of forfeiture: Because you don't hold legal title during the rental period, missing payments or failing to secure a home loan at the end of the contract could mean losing all the ‘equity’ you built up.
Rent-to-buy schemes have since been banned in Victoria, while in South Australia they can only be offered through the South Australian Housing Authority (SAHA).
How do rent to buy schemes work?
While the actual mechanics of rent to own schemes can vary, there are generally several stages in the process. These are:
- 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 details like the purchase price, deposit amount, and how much rent will be paid, as well as any fees. - Signing your rental agreement
You’ll typically then sign on as a tenant for a specified period of time, after which you will have the option to buy. - Putting down a deposit
Rent to own schemes often still require you to pay a deposit, which may be around 1% to 3% of the purchase price. - Paying rent
This rent is normally higher than market rates and can include extra ‘option to buy’ fees. - Finishing the rental contract
At the end of a rent to buy period, the ‘equity’ you’ve built up using a portion of your rent will effectively act as your deposit when you apply for a home loan. - Applying for a home loan
At this point, you will need to seek finance through a traditional bank or lender and take out a home loan. This is the point at which the whole thing can come unstuck as, if you don’t qualify for a mortgage or a lender doesn’t want to take on the property at your purchase price, you might not have a leg to stand on. - Paying off your mortgage
If all goes to plan, the sale will be finalised and you will start paying mortgage repayments to your bank or lender.
Pros and cons of rent to buy schemes
Considering entering into a rent to buy arrangement? It’s important 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 rent go solely to your landlord, a rent to buy scheme sees a portion of your rent payments adding to what’s expected to be your future deposit.
- Price certainty: As the purchase price of the property is agreed upon ahead of time, you have a degree of certainty as you plan and save for the eventual purchase.
It’s worth noting again, however, that both of these benefits can come unstuck at the point a buyer applies for a traditional home loan.
Potential cons of rent to own schemes
- Higher rent: As rents are typically above market rates and fees are often built in, your rental payments are likely to be high comparative to similar properties, 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 anything you’ve already paid.
- No guaranteed purchase: When it comes to the end of a rent to buy contract, you’ll need to borrow funds from a bank or lender to purchase the home. If you or the property doesn’t meet its criteria, you may find yourself unable to buy.
- Landlord related risks: While renting a property, you don’t have legal ownership in it. If the owner forfeits or sells the property, you may lose the money you’ve already paid.
- Potential for inflated prices: When you sign on to a rent to own scheme, the purchase price will be largely up to the seller, and they may inflate this price. This could make your rent more expensive and increase the risk of your eventual home loan being declined.
- 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 buyers are afforded by law.
What to check before entering a rent to buy arrangement
If you’re considering a rent to buy scheme, it’s crucial you look beyond the surface and read the fine print carefully.
Before signing any contract, make sure you understand the following details and get advice from an independent legal professional:
- How is the final purchase price set? Is the purchase price fixed at today’s value, or does it include a built-in price premium based on future market growth? If property prices fall during your lease term, you could end up locked into overpaying for the property.
- Where does your money actually go? Check whether a portion of your rent payments is legally set aside as 'rent credits' or deposit contributions, or if you're simply paying above-market rent with no guarantee.
- Who pays for maintenance, rates, and insurance? Unlike traditional lease agreements, many rent to buy contracts see the renter responsible for ongoing expenses, like rates, home insurance, and structural repairs.
- What happens if you want to end the agreement early or miss a repayment? Ask what happens if your circumstances change and you decide not to purchase the home or you miss a rent payment. In many rent to own arrangements, a single missed payment can void the contract and see you forfeit all option fees and ‘equity’.
- How likely are you to qualify for a home loan at the end? Remember that at the end of the rental agreement, you’ll still need to apply and qualify for a home loan through a traditional bank or lender. Check whether your financial position and credit history will realistically meet lender requirements by that time.
- Independent legal advice. Make sure you have a qualified conveyancer or solicitor review any rent to own contract before signing anything.
What are alternatives to rent to buy schemes?
If you are looking to get into the property market, there are various forms of assistance that may be available to you. These include:
- The 5% Deposit Scheme: This can help eligible first home buyers and single parents enter the market with smaller deposits
- The Help to Buy Scheme: This shared equity scheme sees the Federal Government purchasing a portion of a property alongside an eligible buyer, with the buyer asked to either repay the government’s contribution or provide a portion of the proceeds when they sell.
- Other shared equity schemes: Alongside Help to Buy, many states and territories offer their own shared equity schemes for eligible buyers.
- Help from a home loan guarantor: If you’re struggling to save a deposit, you could ask a friend or family member to be a guarantor on your home loan. Both parties should be aware of the related risks before agreeing to this.
