Most aspiring home owners in South Africa will either take a mortgage or home loan, or buy/build the house out of pocket. Both of these options come with multiple challenges, and many people will not even qualify for a mortgage, let alone have the cash to finance the house themselves.
However, there is a new phenomenon sweeping the country, bringing a new way of looking at home ownership. It is called a rent-to-own or rent-to-buy agreement.
How rent-to-own works
Rent-to-own is a leasing agreement in which a property is offered for rent for an agreed amount of time, at the end of which the renter has an option to buy. The purchase price may or may not be determined at the signing of the agreement.
The details vary from developer to developer, but in most cases, the renter gets to live in the house like any other tenant, but is offered the first right of refusal (This is a contractual right to offer the house to the renter to buy, before anyone else).
The way the tenant guarantees this first right of refusal is by paying an additional sum of money on top of their monthly rental fee. In most cases, this additional amount will serve as a down payment, and will be deducted from the eventual purchase price. Some contracts can however differ on this.
However what is certain is that should the tenant fail to take up the purchase offer after the agreed period, the additional fee they have been paying is forfeited. This makes the practice risky, and is only advised for those who are almost certain they will be taking up the house.
Any aspiring home owner getting into a rent-to-own agreement should consult a professional to make sure all these stipulations and protections are included in the agreement. Otherwise, nothing would stop a dishonest landlord from selling it to another person without first offering it to the tenant. Or even raising the purchase price beyond the reach of the tenant.
Another way rent-to-own can be structured is where the tenant pays separate installments towards the purchase price, while simultaneously paying the monthly rent. Legal counsel is important on this one, because it mostly operates in a gray area.
Advantages of rent-to-own.
1. It eliminates the need for a huge upfront investment: The cost of buying a house is astronomical. Even before paying for the structure itself, you may end up burning all your finances paying for legal fees and transfer fees, deposits etc.
It is rare for a lender to finance 100% of your house, which means you will have to spend out of pocket. In South Africa, you will find yourself putting up 10 – 15% of your own money, before the purchase can go through. Rent-to-own spreads this money over a long period of time, which makes it suitable for people without instant access to large sums.
2. Rent-to-own offers a home ownership path for those with a bad credit score.
3. It offers aspiring home owners the first right of refusal to owning desirable houses in desirable locations.
4. Gives the aspiring home owner enough time to organize their finances: This is particularly useful in cases where there is future expectation of substantial income.
5. With the right agreement, rent-to-own can freeze the price of a property: Assuring the renter that a few years from now it will be available to them for a specific amount. This is important since home prices are almost always rising.
Disadvantages of rent-to-own
1. The biggest disadvantage is the risk of forfeiting money: The additional payment you’ve been making per month is lost if you opt not to take up the offer to buy at the end of your agreement.
It is not uncommon for unscrupulous sellers to make it unattractive for you to buy, so they can pocket the money. Also, when the time comes to make the purchase, a lot can have happened to your circumstances thus preventing you from taking up the offer, including your housing taste, your finances, your job location etc.
2. Less control over the house: Until you make the purchase, you have very little control over the house. This can include small issues like maintenance, or even very serious issues like foreclosure if your landlord had stopped making mortgage payments.
3. Home prices may fall: It is rare, but it does happen. By the time your agreement requires you to make the purchase at an agreed price, the home prices in that neighbourhood may have fallen. At this point, you have very little leverage to re-negotiate a better purchase price.
4. Late payments: Even after paying additional fees religiously for long, you may lose your first right to purchase with just a few late payments.
In South Africa, you can find rent-to-own property on websites like Gumtree.