Rent to Own | Option to Purchase

If you are unable to read this entire article, then my advice is simply "Don't do it. There is no such thing in the law as a Rent To Own Agreement. The idea was made up by people who wanted to sell to someone who did not qualify for a mortgage. There is a good chance it will lead to a problem and a dispute." If you want more information, then read on.

Rent to Own Contracts

The concept behind a rent to own contract is that a person agrees to pay a lump sum to the seller up front as an "option price" in order to have the right later on to purchase the property at an agreed price. Some contracts say so. Others are vague about it. In the meantime the buyer is only called a tenant and must pay monthly rent. The rent might be at a higher than usual rate, but not always. A portion of the monthly rent is often credited against the eventual purchase price of the property. The agreement states that the buyer/tenant is only a tenant with an option to purchase the property. They are not an actual purchaser. If a person enters into this type of contract fully understanding the legal difference between this type of contract and an agreement for sale, and they have not built up a great deal of equity, then I have no problem with this arrangement. That's assuming it's written up properly. Sometimes they are not. In addition, I believe that quite often, people do not understand the legal implications or how this arrangement may not be in their best interests.

Sometimes the buyer enters this type of arrangement in the belief that they have purchased the property and are paying the price over time. That often is not be the case. There is a very important distinction at law between an "option to purchase" and an "agreement for sale" of land. In an agreement for sale, the purchaser makes monthly payments to the vendor ... usually with interest. Title to the property remains in the vendor's name until the entire purchase price is paid. Then title is transferred. If, for example, the purchaser loses his or her job and falls behind on payments, the seller cannot immediately evict the person and cancel the sale. In Saskatchewan, an agreement for sale can only be cancelled by court order. The procedure is virtually identical to the foreclosure process and roughly takes on average 9-13 months to complete. If the purchaser brings their payments up to date in the meantime or finds a mortgage to pay out the seller, they can do so and retain their rights. They have ample opportunity to deal with an unforseen problem and can save their investment.

Option to Purchase

An option to purchase is very different. Under an option, the "buyer" is not really a buyer. He or she is actually only a tenant of the property. If they default in lease payments, some versions of the "rent-to-own" agreement will say that their option is terminated. In virtually all of them, it will say that if they do not pay out the purchase price by a given date, they will have lost everything they have paid to date. For example, if an option agreement states that the option must be exercised and paid in full by a specified date, even if the tenant is one day late on paying the price, the option is void and they will have lost everything they have paid so far. They will lose the right to buy the property at the agreed price. They will lose the cash they paid up front. They will lose the equity they had paid down each month. They will lose any rights to the improvements they made to the property (if any). This harsh result cannot happen with an "agreement for sale" but it can under a rent to own agreement.

Get Legal Advice

If a buyer is fully informed on the risks and has minimal equity in the property, then they are free to enter into any agreement they wish. However, I suspect the buyer usually does not understand the legal distinction between the two types of agreements. The seller may not understand or want to tell them. To compound the problem, the seller may ask the buyer to use the same lawyer to make things go "more smoothly". The result may be that the buyer/tenant will not receive independent legal advice.

In some cases, the court has ruled that this type of agreement is actually an "agreement for sale" at law, in spite of what the contract states. This may be the case when the buyer has built up substantial equity in the property or where the buyer and seller have acted more consistently in that manner as opposed to a landlord and tenant arrangement. However, that will probably only happen if the buyer has the knowledge and resources to seek legal help.

As I have said already, every case is different and a rent-to-own agreement may be fair and reasonable in some cases ... but only if the buyer/tenant is fully informed before they sign and hand over any money.

Problems Getting Financing Later On

Since originally writing this article I have also learned another reason why rent-to-own arrangements can be problematic. Apparently, it may be more difficult for the so called tenant to obtain financing with a conventional lender when they are trying to obtain mortgage financing to pay out the owner. This is often because the bank will not recognize the past payments as part of the down payment. They will consider no downpayment to have been made so far. Often, the buyer won't have enough cash to satisfy what the bank wants you to pay down when getting the mortgage. Since the buyer cannot get a mortgage, they cannot exercise the option and they lose their investment.

You should check with a bank or mortgage broker for their input on this issue. I have seen brokers tell clients that it will not be a problem, only to discover after the application is submitted that in fact it is an insurmountable problem

Other Potential Disappointments for a Buyer

Often on these types of sales, the seller still has a mortgage on the property. It will probably be registered ahead of the buyer in this arrangement. If the seller defaults on their mortgage, the mortgage company may take title by foreclosure and the buyer would lose their investment in the property. Even if this does not happen, if the balance owing on the mortgage plus property tax arrears is higher than the amount remaining owing to the seller, there again will be a problem for the buyer.

If the seller has financial problems and judgments are registered against the title, whether above or below the buyer's registration, the seller may not be able to complete when it comes time to transfer the property to the buyer.

Some sellers draft agreements saying that whenever the buyer completes the purchase, the buyer must pay the prepayment penalty charged on the seller's mortgage. It may only be a thousand or two dollars, which by itself is an added burden to the buyer, but it may also amount to many thousands of dollars, all at the expense of the buyer.

A Caution Against Vendor Financing

If you are a vendor considering financing a purchaser who is unable to obtain mortgage financing, I urge you to think twice about doing that. If a buyer has not been able to obtain mortgage financing, there is usually a good reason for it ... based on their credit. If a bank feels that they cannot afford the potential risk or loss, how can you as a vendor feel you can afford to take the risk? In Saskatchewan, if a buyer is in default under an agreement for sale, it will take a long time to get the property back. In the meantime, taxes will continue to accrue. The house may be left uninsured and it might not be maintained adequately. You will spend a great deal in legal fees to take back the property and much of it may never be recovered. You will need to incur the expense of selling the property again. You will continue losing money and paying bills until the sale is complete. At the end of the day, you will likely have suffered a substantial loss. The law in Saskatchewan does not allow you recourse against the buyer for the shortfall if the buyer is an individual. You may have a remedy if you have a guarantor and the guarantor is able to pay. If you are considering this type of arrangement, think carefully and seek legal advice from a lawyer with experience in this area of the law.