As a newcomer, owning a home in Canada may be the ultimate dream—an unmistakable sign that you’ve settled down in your new country. However, in the current economic situation where house prices are at their peak and interest rates are high, buying a home within a few years of arriving in Canada isn’t easy for many newcomers (or even Canadians).
Housing affordability is a known challenge in many large Canadian cities, and new models of homeownership, such as rent-to-own are gaining popularity. The rent-to-own model has the potential of being able to fast-track your homeownership dreams in Canada, by eliminating the need for a large down payment and giving you more time to build your credit score. In this article, we cover in-depth how the rent-to-own model can make buying a home in Canada as a newcomer easier.
In this article:
What does rent-to-own mean?
The rent-to-own model of homeownership allows you to rent a home that you intend to, or agree to, buy at the end of your lease agreement. In such a situation, the monthly amount you pay is divided into two parts—a larger percentage that goes toward your rent and a smaller percentage that contributes to your down payment and home equity (typically called rent credit). In other words, a portion of your monthly rent goes toward the purchase of the residential property that you’re renting.
A rent-to-own agreement involves two sets of contracts: a rental agreement and a rent-to-own agreement. You and the landlord (or property company) will sign both these contracts before you move into the home.
Depending on your contract, a rent-to-own program may last between one and five years. Although the terms of rent-to-own deals vary significantly, it is typically an agreement between a renter and property owner or investor to buy a home at a set price at a future date. The builder or property company holds the mortgage on the home until the end of the lease term and then transfers it to the new owner.
Rent-to-own models are best suited for renters who’re struggling to get mortgage approval due to insufficient Canadian credit history (such as newcomers), poor credit, or low income. It may also be ideal for newcomers who’ve found their dream home and want to lock in an agreement to purchase it at the current market price but don’t have enough funds for a down payment or a sufficiently high credit score yet.
Types of rent-to-own programs in Canada
There are two key types of rent-to-own programs in Canada, depending on whether the tenant makes a commitment to purchase while signing the lease. The two program types are:
In an option-to-purchase agreement, the tenant has the option to buy the home after the rental term is completed, but the purchase isn’t necessary. Usually, the tenant will pay an option deposit when the lease agreement is signed and then make monthly payments for the duration of the lease. However, with this form of rent-to-own agreement, the tenant can decide not to purchase the home at the end of the term without paying a penalty.
A lease purchase is when a deal to purchase the property is signed along with the rental agreement. Consequently, if the tenant backs out or decides not to buy the home at the end of the lease term, they will lose their deposit and rent credit and may even need to pay a penalty. When this type of rent-to-own agreement is signed, the tenant pays a small down payment and then makes monthly rental payments.
Advantages of rent-to-own programs in Canada
As a newcomer, there are many reasons why rent-to-own programs can be an easier path toward homeownership. These include:
- The purchase price is locked-in: In most rent-to-own contracts, the future purchase price of the house is locked in. This price may be the current market price or the future appraised value at the end of the lease term. Regardless of what the agreed-upon price is, rent-to-own programs can insulate you against drastic increases in property prices over the term of your lease.
- Require a smaller down payment: Rent-to-own programs allow you to put down a smaller deposit or down payment compared to what you would pay while purchasing the home outright. A portion of your monthly rental payments will contribute to the remaining down payment amount.
- More time to build your credit history: With a rent-to-own agreement, you’ll only need to get a mortgage at the end of your lease term, so you’ll have more time to build your credit history in Canada. During the lease term, you’ll keep making monthly rental payments and accumulate rent credit, and then apply for a mortgage to purchase the house at the end of the term. Speak to an RBC Newcomer Advisor for tips and guidance on how you can improve your credit history as a newcomer.
- Allows you to live in your dream home: Love a house but can’t afford it just yet? Rent-to-own programs let you move into your dream home even if you can’t afford to own it in the beginning. Moreover, you’ll have an option or agreement to buy it at a later date.
Disadvantages of rent-to-own programs
Rent-to-own programs may not necessarily be the best option for everyone. Here are some disadvantages you should be aware of before signing such an agreement:
- Penalties if the purchase falls through: If you’re not approved for a mortgage at the end of your lease term or if you change your mind, you could lose any deposit and credits you’ve paid towards a down payment during your lease term and may face additional penalty fees.
- Higher monthly cost than renting: The monthly rent you pay during your lease term will include not just the rental price but also rent credits that contribute to your down payment. Many newcomers operate on a strict budget during their initial months in Canada, and not everyone can afford to pay higher-than-average rent until they are well-settled in Canada. If you’re unsure about how much rent you can afford to pay, use Arrive’s free Cost of Living in Canada calculator to estimate your total monthly living costs and create an accurate budget.
- Higher upfront cost than renting: You’ll need to pay a down payment or option deposit of at least two or three per cent of the cost of the home when you sign the agreement. Paying this lump sum amount might not always be feasible for newcomers during their initial months in Canada.
- Other costs of homeownership: When you sign a rent-to-own agreement, you’ll be responsible for covering the cost of maintenance and repairs, if any, on the home. The homeowner typically covers these costs, and as the future or prospective owner, you’ll be responsible for these costs from the beginning of your lease term.
- Tenant screening process may be more rigorous: When landlords undertake tenant screening while renting out their property, their concern is whether the tenant will be able to pay rent on an ongoing basis. However, when you sign an agreement to purchase the home at a later date, the property owner is taking a higher risk and stands to lose out on not just rental income but also on the mortgage amount they’ve been paying on the home. So you may be held to a higher standard in the selection process.
How are rent payments calculated under rent-to-own programs?
Even though the monthly payments you make under a rent-to-own agreement are called rent payments, it’s not just rent that you’re paying. So how exactly are your rent payments calculated under rent-to-own programs?
As a tenant, you’ll make regular monthly payments of the amount agreed upon in your contract. These payments are divided into two parts, with one larger portion (about 75 per cent) of each payment going toward the rental amount and the other (about 25 per cent) going toward the down payment and eventual home equity.
Usually, the monthly rent in rent-to-own situations is slightly higher than market prices of similar rental properties, but the excess amount goes towards your down payment and is also known as rent credit.
Some rent-to-own agreements, especially ones with three to five-year terms, may include clauses on year-on-year rent increases (much like in regular lease agreements).
How does rent-to-own work in Canada
Let’s explain how rent-to-own agreements and payments work with an example.
What the Canadian government is doing to make rent-to-own homes more accessible
Affordable housing and housing for new immigrants are both challenges already on the Canadian government’s radar. Recently, the government earmarked $200 million for a rent-to-own program announced in August 2022 (as part of the five-year Affordable Housing Innovation Fund). This fund, managed by the Canada Mortgage and Housing Corp. (CMHC), will encourage developers and builders to create more opportunities for first-time homebuyers who are overwhelmed by down payment requirements.
To be eligible for CMHC funding, housing providers must demonstrate how they’ll facilitate prospective buyers transitioning from renting to owning a home within five years. Eligible housing providers must also ensure that sufficient safeguards and consumer protections are in place for prospective home buyers, such as:
- At least a partial refund of payments made in excess of market rent (minus administrative costs) in the event the sale does not go ahead as planned.
- Limits on rent increases that are in line with the annual increase permitted under applicable legislation/regulations or, in the absence of regulations limiting the annual increase of the unit, rent increases limited to the applicable consumer price index.
- Clearly mentioned sale price or methodology for determining the future sale price.
Several private builders and property companies also offer rent-to-own programs that are not backed by the CMHC. However, the contractual terms may differ for those programs.
What happens if the tenant decides not to buy the rent-to-own home?
There’s always a chance that you may decide against buying the home or be unable to do so after the lease term ends. For instance, your situation may change and you may need to move away from the city or perhaps you just did not enjoy living in the home. It’s also possible that you may not qualify for a mortgage when your lease term ends.
In such cases, you may lose the deposit or down payment you paid initially and any rent credits you may have accrued. Some contracts may include penalty clauses as well and you may have to pay an extra sum over and above what you’ve already paid.
Generally, builders under the CMHC funding program must have contract provisions that ensure that the tenant does not lose their entire rent credit amount (you may be eligible for a partial refund). To ensure that you’re fully aware of your rights as a tenant and future owner, as well as your liability in the case of contract termination, please read the contract or contact a property lawyer before signing a rent-to-own agreement.
Why rent-to-own programs may be best-suited for newcomers to Canada
As a newcomer, rent-to-own programs give you the flexibility to fulfill your dream of homeownership in Canada faster. You may be able to lock in a home purchase price and pay a fixed monthly rent until you’ve had a chance to build a good credit score and save for a down payment. Moreover, rent-to-own programs allow you to move into your dream home even when you’re still a few years away from being able to afford it. However, keep in mind that the terms and conditions for rent-to-own programs vary significantly based on the builder or property owner, so always consult with a lawyer to make sure the decision is in your best interests.