Rent-to-own schemes: What are they and why are they so risky?
Rent-to-buy schemes appear to allow tenants to lease their home with the option to buy it later. Sometimes tenants are even told a portion of their rent will go towards a deposit on the property. However, these schemes commonly demand inflated purchase prices, significant fees, and come with strict conditions that can see buyers lose thousands if anything goes wrong. Because the contracts are complex and largely unregulated, many consumer advocates warn that rent-to-buy deals can leave would-be homeowners worse off - and sometimes with no home at all.
What are rent-to-buy or rent-to-own schemes?
Rent-to-buy schemes (often called rent-to-own, lease-to-own, or lease-plus-option) promise renters the option of buying the property they’re renting, usually after a certain number of years, at a pre-agreed price. This pre-agreed future price is usually inflated to cover any potential property price rises.
On top of paying rent during the rental period, tenants generally have to pay fees for the option of buying the property in the future. In some cases, renters may also be charged a non-refundable deposit and other outgoings an owner-occupier would typically pay for, such as building maintenance, stamp duty, and insurance. These costs are then deducted from the final sale price if they choose - or are able - to purchase the property.
Former Consumer Action Law Centre CEO Gerard Brody called rent-to-buy schemes "rip-offs" in 2019.
“These finance options are usually targeted at low-income earners, playing on their dreams of owning their own home,” he said.
“The protections home buyers would usually receive when taking out a mortgage don’t apply to vendor term and rent-to-buy finance agreements. Nearly every deal we have seen has been destined to fail from the start because they were unaffordable for the buyer.”
Savings.com.au’s two cents
There are many things that can go wrong in a rent-to-buy scheme and, if you're considering entering into a rent-to-buy agreement, experts strongly advise you to seek qualified independent financial and legal advice. It's also pertinent to thoroughly research these schemes first so you have an understanding of the risks and costs associated.
Rent-to-buy schemes are illegal in Victoria and South Australia. If you've entered into one in either of these states, you may be able to retrieve all money paid except that deemed typical market rent for the period you lived in a property.
It's important to note that some state governments have been known to offer rent-to-buy pathways, or schemes that appear similar, to eligible residents. These are generally low-risk options that may help some would-be homeowners enter the market.
How do rent-to-buy schemes work?
Private rent-to-buy schemes (those not offered by a government) generally work in one of two ways:
- The provider purchases or develops a property and offers it up under a rent-to-buy scheme
- The renter chooses a property and the provider purchases it under the guise the renter can buy it over time
After the property in question is secured by the provider and offered up to prospective tenants, there are then typically two phases to the arrangement - the rent stage and the purchase stage.
Rent-to-buy schemes are often marketed as though the tenant is building ‘equity’ while paying rent. This is a misuse of the word 'equity', as any portion of rental payments going towards the purchase price act more like pre-payments or credits - if the agreement is forfeited, whether by choice or circumstances, the tenant holds no ownership rights over the property.
Rent phase
Rent-to-buy programs are few and far between in Australia, with only a few developers and companies offering them. Once you’ve found a rent-to-buy program and identified the property you want, you then sign a contract or lease agreement.
Some rent-to-own contracts require a non-refundable deposit to be paid. Rent-to-own schemes also typically require the tenant to pay an ‘option to buy fee’ on top of their regular rental payments. This ‘option to buy fee’, which can amount to tens of thousands of dollars over the lease term, is then seemingly deducted from the purchase price of the property, thereby acting as a form of deposit. Sometimes, this option-to-buy fee will be built into the regular rental payment, so you’re paying far more than the market rent for that area.
However, if you decide not to go through with the purchase of the property or you are unable to, that money will not be refunded.
Rent-to-own schemes often also require the tenant to pay for outgoing costs such as insurance, maintenance, and stamp duty during the renting phase. These costs aren't refundable if you decide not to go through with the purchase of the property.
During the rent phase, you have no legal right in the title to the property. Even missing one rental payment can result in having the contract terminated and losing all the money you’ve spent.
Buy phase
If you decide to go through with the purchase after the rental period has come to an end, you’ll likely be required to take out a home loan to buy the home. Any extra ‘equity’ you’ve accrued during the rental phase will be deducted from the purchase price. However, this can present a roadblock.
As the purchase price of the property is typically agreed upon at the start of the agreement, factoring in assumed property price growth through the rental period, it might not align with the property's true market value when the time comes. If the property's value has flatlined or fallen and the 'equity' you've built up doesn't meet the shortfall, a lender might not be willing to provide a mortgage for the property.
Additionally, there's more to home loan eligibility than having a deposit. If your income isn't enough to service a home loan or you don't qualify for another reason, you might be out of luck.
If you get approved for a home loan, the title of the property will be transferred to your name and you become the legal property owner. Then it’s just a matter of paying off the mortgage.
Are rent-to-buy schemes legal in my state?
The laws surrounding rent-to-buy schemes vary from state to state, but they are banned in a few states because of their high risk, which should probably tell you all you need to know about using one.
A 2016 Consumer Action Law Centre report said the vague legislation surrounding rent-to-buy schemes puts buyers at risk.
“Overlapping laws can make legal requirements and obligations unclear. Gaps in the law can leave people with limited or no legal protections if things go wrong,” the report reads.
“The effectiveness of legal protections varies depending on the people involved and the nature of the transaction.
“This legal uncertainty, coupled with a lack of independent legal advice, is why the risks of these schemes are so significant, particularly for buyers.”
The Consumer Action Law Centre has recommended they be banned in all states and territories, but so far only Victoria and South Australia have banned them.
Risks of rent-to-buy
As you may have surmised by now, rent-to-buy schemes are inherently risky. According to Consumer Action’s report, these are the biggest risks of rent-to-buy schemes for buyers and vendors:
Risks for buyers
The buyer isn’t the legal owner until they successfully take out a home loan
One of the biggest risks of rent-to-buy schemes is that the buyer isn’t the legal owner until they have successfully applied for a home loan and the title of the property is transferred into their name.
“Because buyers do not seek independent legal advice, they do not understand this significant legal risk,” the Consumer Action report reads.
Deals can be unaffordable to begin with
Consumer Action says most rent-to-buy deals they’ve seen were “destined to fail” from the start because they stretch buyers who apply for these types of schemes beyond their financial limits.
“Buyers are typically on low incomes, often reliant on Centrelink payments, and may have significant debts,” the report reads.
“Many buyers who do not qualify for mainstream finance cannot afford an overpriced property at a high interest rate plus outgoings.”
Refinancing is usually impossible
According to the Consumer Action report, people who have signed up to rent-to-buy schemes because they couldn’t obtain a mainstream mortgage in the first place will find it “virtually impossible to refinance”.
This is either because the buyer hasn’t built up enough ‘equity’ in the home and can’t take out a home loan, or because their financial situation hasn’t improved enough to be eligible for a mainstream home loan.
Since they can’t refinance, a buyer that’s struggling to meet the repayments may feel the need to move out, in which case the contract is terminated and they lose all the money they’ve poured into the property.
Hidden costs
Consumer Action says there are often significant costs buyers may not be aware of when signing up to a rent-to-buy deal, such as maintenance, repairs, and even stamp duty and capital gains tax, which would typically be covered by the owner in a normal renting scenario.
If the renter never manages to successfully buy the home, they can lose this money.
Missing just one payment risks everything
If you miss just one payment, the normal protections that come with a mortgage or residential tenancies laws like eviction procedures or hardship measures don’t apply, and the buyer can have their contract terminated and lose all the money they’ve spent so far.
The purchase price of the property is inflated
When a buyer signs up for a rent-to-own scheme, the final purchase price of the property is set at the beginning. While this may protect the buyer from potential future house price rises, Consumer Action’s report found the final sale price is usually “inflated” well above market values, with one case study reporting their property was actually worth up to $46,000 less than the agreed price.
Not only is the price inflated, if the market falls you risk paying even more for the property than what it’s worth.
First home buyer loses $150k in rent-to-buy scheme
The then-22-year-old used a rent-to-buy scheme to purchase her first property with her partner in 2008 after the birth of their first child.
“We didn’t qualify for a bank loan at the time and the way the scheme was explained to us, it was simple,” she told Savings.com.au.
“All we needed to do was make repayments for a year or so and then we’d be able to show the bank we could maintain the home loan repayments.”
She said she understood how the rent-to-buy process worked, but didn’t seek legal representation for the contracts which they were advised to do.
It all went wrong when they tried to take out a mortgage from a mainstream lender to buy the home at the end of the rental period.
“A couple of years into the contract, we tried to get traditional finance. Unfortunately due to the Global Financial Crisis, we were not approved as we had no savings to account for given the majority of our income was going on the loan and childcare,” she said.
They sought the advice of a lawyer who helped them terminate the contract, but they still lost over $150,000 that they had spent in option to buy fees and other outgoing costs.
“One positive side to this story is that our lawyer told us whenever you’re ready to purchase the traditional way make sure to get in contact with me. A few years later we were lucky enough to do this all thanks to his help in the first instance.
“It’s good to know despite losing a lot of money and heartache that there are some good people out there still.”
She says she would advise anyone looking to use a rent-to-buy scheme to do their research first.
“I tend to give advice to anyone considering such an agreement to do their due diligence and check with the right channels prior to signing an agreement.”
What to consider before entering a rent-to-buy scheme
If you’re still considering entering a rent-to-buy scheme after reading all of the above, there's a chance you're feeling either unusually optimistic or so stuck that you're willing to consider significant financial risks.
Whether that's the case or not, before you sign any contract, read the fine print thoroughly and strongly consider seeking independent legal and financial advice, particularly around the costs and risks associated with entering such a scheme. With rent-to-buy schemes banned in certain states and many experts and consumer advocates firmly against these schemes, it’s definitely worth doing your research and seeking legal advice before signing up.
Alternatives to rent-to-buy schemes
People who use rent-to-buy schemes usually do so because they don’t qualify for a mortgage from a mainstream lender, either because their income isn’t high enough or they have a bad credit rating. Unfortunately, this makes rent to own schemes that much riskier, as participants might not be able to secure a home loan once their agreement ends.
But there are other ways you can get into the property market. You could consider a low deposit home loan or a low doc home loan. You may also want to consider taking advantage of first home buyer incentives, such as the 5% Deposit Scheme, a First Home Owners Grant, the First Home Super Saver Scheme, or the Help to Buy scheme, if you’re eligible. You could also consider using a guarantor to secure your home loan. While most solutions come with some sort of downside, it’s still worth comparing all your options.
Buying a home or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for owner occupiers.
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Extra Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
5.94% p.a. | 5.98% p.a. | $2,978 | Principal & Interest | Variable | $0 | $530 | 90% |
| Promoted | Disclosure | ||||||||||
5.89% p.a. | 5.80% p.a. | $2,962 | Principal & Interest | Variable | $0 | $0 | 80% |
| Promoted | Disclosure | ||||||||||
5.99% p.a. | 6.02% p.a. | $2,995 | Principal & Interest | Fixed | $0 | $0 | 60% |
| Promoted | Disclosure | ||||||||||
5.93% p.a. | 5.93% p.a. | $2,975 | Principal & Interest | Variable | $0 | $395 | 70% | Disclosure |
