South Africa’s property industry has been navigating through unchartered territory with industry dynamics sharply impacted by the Covid-19 pandemic. The prevailing climate has resulted in reduced household incomes which has mostly impacted the rental market. On the flip side, financial institutions have been offering home loans with record low interest rates.
The South African Reserve Bank cut interest rates five times this year, reducing the prime rate to 7%, the lowest level since 1966. Buyers who previously could not afford a property are entering the market for the first time due to lower interest rates and lower transfer duties, particularly in the middle-priced segment.
First-time buyers are streaming into the market, accounting for 54% of Ooba’s mortgage bond applications processed in the third quarter, a 10% increase compared to the third quarter of 2019.
On the other hand, the number of vacant rental properties in SA has increased by 50% since the start of the year, as the coronavirus crisis wreaks havoc on household incomes. Across the market, 11% of properties are now standing empty. And only 60% of tenants of pricier properties are paying rent on time.
Households are required to choose between the homeownership and home rental option, the former option being a far more interest rate sensitive decision due to the fact that many households use a mortgage loan to finance this. Therefore, all other things equal, a sudden reduction in interest rates makes the home buying option more attractive relative to the rental option.
For those who are considering renting to own, how does it work?
What is rent to own?
Rent-to-own or rent-to-buy are effectively leasing arrangements which provide for the rental of a property for an agreed period of time, plus additional payments, and at the end of a set time, the renter has the chance to buy. This arrangement allows buyers – usually those unable to save a deposit and secure traditional financing – to “get into a home” without substantial upfront costs.
Rent-to-own agreements include a standard lease agreement to buy the property at a later time.
What types of lease agreements are involved?
Lease-Option vs. Lease-Purchase
Two different types of rent-to-own contracts you need to be aware of are the lease option and lease purchase.
Lease-option contracts give you the right, but not the obligation, to buy the home when the lease expires. If you decide not to buy the property at the end of the lease, the option simply expires, and you can walk away without any obligation to continue paying rent or to buy. This is not always the case with lease-purchase contracts. To have the option to buy without the obligation to buy, it needs to be a lease-option contract.
Advantages of Rent to Own Contracts
- One of the main reasons why rent to own agreements are attractive to renters is because they can engage to a contract even though they have a bad credit status. He or she can improve their credit rating by renting the property and later on, they may be able to get a loan to purchase the property.
- By renting a lease to own property, you have the chance to actually live in and inspect the home and decide whether it is a wise decision to buy it or not. Later on, you have the option to leave the property if you find some problems with it.
- The contract price upon negotiation is fixed and final. That means where there is a price appreciation, the purchase price remains the same and the seller cannot increase the prices throughout the contract time frame. While this is a great advantage to rent to own homes, there could also be drawbacks when the market reacts in the opposite way.
- Initially, a rent-to-own can be an expensive proposition because, in addition to the monthly rent, you are obliged to spend an additional amount of capital towards rendering the down payment.
- You can end up getting embroiled in unwelcome legal troubles in case you indulge in the breaching and violation of a rent-to-own contract. Also, if you skip a payment or do not adequately maintain the property, you run the risk of getting evicted from your home as per the contractual terms, and all your rent-to-own money will be forfeited.
- The contract specifies not just a fixed and confirmed selling price of the home but also dictates you to pay a non-refundable deposit to the homeowner. Therefore, as a tenant, when you wish to buy the apartment at a reasonably affordable price, later on, owing to a probable drop in the property prices, you will experience a disappointment as you are legally bound to pay only the pre-decided amount.
- Once the rent-to-own contract ends, if you decide not to buy the house, it means that all the money you spent eventually went into paying the rent only. You could have opted for a smaller place with a less expensive rent in the beginning and used your extra savings towards making a down payment for purchasing another house.
Things and risks to consider under this arrangement
Risks for Buyers
Some of the things to consider before entering into a rent-to-own agreement include:
- Forfeiting money: If you don't buy the home, you lose all the extra money you paid. Sellers may be tempted to make it difficult or unattractive for you to buy so they can pocket your investment.
- Slow progress: You might plan to improve your credit or increase your income so you’ll qualify for a loan when the option ends, but things might not work out as planned.
- Less control: You don't yet own the property, so you don’t have total control over it. Your landlord could stop making mortgage payments and lose the property through foreclosure, or you might not be in charge of decisions about major maintenance items.
- Falling prices: Home prices might fall, and you might not be able to re-negotiate a lower purchase price which will result in you being left with the option of forfeiting all your option money or buying the house. If your lender won’t approve an oversized loan, you’ll need to bring extra money to closing for a down payment.
- Late payments hurt: Depending on your agreement, if you don't pay rent on time, you may lose the right to purchase, along with all of your extra payments. In some cases, you keep your option, but your extra payment for the month is not counted, and won’t add to the amount you’ve accumulated for eventual purchase.
- Home issues: There might be problems with the property that you aren’t aware of until you try to buy it — such as title problems. Treat a rent-to-own purchase like a real purchase. Get an inspection and title search before diving in.
Risks for Sellers
Some of the risks sellers face when entering into rent-to-own agreements include:
- No certainty: Your renter might not buy, which means you have to start all over again and find another buyer or renter — but at least you get to keep the extra money.
- Slow money: You don't get a large lump sum, which you might need to purchase your next house.
- Missing appreciation: You typically lock in a sales price when you sign a rent-to-own agreement, but home prices might rise faster than you expected. You have to accept this or wait a while to offer the option to buy.
- Falling home prices: Home prices might fall, and if your renter does not buy, you would have been better off simply selling the property.
- Discovering flaws: Buyers may discover flaws you never knew about and they may decide not to buy. For example, the plumbing might be adequate for a couple, but not a family of five. Although this defect never came up under the previous living arrangement, it is now an issue you’ll have to fix or disclose to future buyers.
Renting to own is definitely a viable option but the onus to carefully consider what to sign up for remains on the seller and buyer.
*Article sourced from Private Property*
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