How does Rent to Buy work?
In a Rent to Buy transaction, the provider will purchase a home that you choose. They will then agree a purchase price at which you can buy the home back from them in a predetermined period of time (usually 3-5 years).
In that period of time you pay a monthly fee that is part-rent part-purchase so that by the end of the period you will own enough to have a deposit for that property.
How do they choose the repurchase price?
Most of the time the company will have some investors backing them, who put up the money with which they can buy the homes. Those investors will demand a certain amount of return on their investment. Assume that return is 5% per year, then your yearly rent plus the capital appreciation minus all costs must equal 5%.
How does my rent turn to equity?
To simplify the explanation, they might tell you that you pay rent and some of it turns to equity. In fact, you’ll likely be paying market rate rent plus some equity payments. They are shown as one for ease
Who is this good for?
If you have enough of a salary to get a mortgage but no deposit, this is a great way to build your deposit whilst moving into your dream property already. If you have bad credit this is also a great way to move into your dream home and build equity whilst improving your credit score.
What’s good about Rent to Buy?
The biggest benefit to Rent to Buy is allows you to move into your dream home today, and that you are locking in a future house price. You know what the repurchase price is in 3-5 years, if property prices in general rise by more than that then you have yourself a bargain.
It is also a great way to get onto the property ladder with a small or no deposit. You can rent the property whilst you prepare to ‘graduate’ onto a mortgage and buy the property in full.
What to watch out for
The biggest risks with this are that you could not be ready to buy the property in the predefined time period or that the locked-in price is higher than the market value of the property.
If you cannot afford to buy the property in 3-5 years or choose not to buy it, you may lose the money that you have put into it so far (depends on the provider). If you don’t lose it all you will probably lose some, so make sure to read the T&Cs. This is a problem if circumstances change and for example your credit deteriorates, your salary drops or if you choose to relocate.
The price cap sounds like a great feature in theory, but if property prices drop or don’t rise as much as expected, and in 3-5 years the property is worth less than what you’ve agreed to pay for it, you may not be able to get a large enough mortgage to buy that property. That is because when you apply for a mortgage, the bank will only lend you the lowest of the value of the property or the agreed purchase price. If the bank thinks the property is worth less than the agreed amount, then that’s the maximum they’ll lend you.
Want to read about other alternatives to buying a home with a mortgage? You can find out more here