Household debt among Canadians has never been higher and is leaving many people unable to consider home ownership because of the strict criteria that Canadian banks follow when considering someone for a mortgage. Adding to the barriers created by the banks is the often insurmountable challenge that heavy debts impose as people try to reduce their debt while saving enough for a down payment.
Over the past few years the concept of lease-to-own (LTO) homes has become increasingly popular in Canada with renters looking for other ways to become a home owner sooner. This approach allows a tenant to lease a home while building their down payment with every cheque they give their landlord. In this article we look at the basics and consider the differences in successfully completing a lease-to-own in Canada.
Let’s start by explaining what a lease-to-own is.
A Lease-To-Own is an agreement that gives a renter the right to purchase a property. It consists of two parts: an option, which is the right to purchase the property for a specific price for a certain period of time, and an occupancy (lease) agreement.
Occupancy (lease) Agreement + Option to Purchase = Lease-To-Own Agreement
Other terms which are used to refer to lease-to-owns are Rent-to-Own, Rent-to-Buy, Lease Option, Lease with option to Purchase, RTO and LTO.
So how does a LTO work? The easiest way to explain this is that someone buys a home for a tenant who then leases the property for an exaggerated amount from the buyer in order to build a down payment, fix their credit and reduce their debts.
Each lease payment includes a monthly option credit that usually accounts for 20% of the amount. This is money that is paid above typical rents in the area and is used to build a down payment.
These credits accumulate over a 24 or 36 month lease term to be counted as part of the overall down payment when the tenant purchases the home. The rest comes from a non-refundable deposit paid by the tenant before they choose their home. The downpayment must be enough to qualify for high ratio mortgage insurance from CMHC (Canada Mortgage and Housing Corporation) as well as cover the final closing costs.
So far I’ve revealed the basic structure of a lease-to-own home. One important difference with a Canadian LTO is qualifying for CMHC insurance. Another worth highlighting is the very strict criteria used by Canadian banks to qualify someone for a mortgage. Gettting approved is more difficult and presents a very real challenge to successfully completing a LTO in Canada and so we consider this next.
In order for a lease-to-own to be successful the tenant must be able to purchase the home once they’ve exercised their right to do so. If getting approved for a mortgage is tougher in Canada then the question you might ask is how do I know that I’ll be able to qualify for one?
This question must be considered at the beginning of the LTO process, and not at the end. It is wise for a tenant to approach an accredited Ontario mortgage professional and/or credit councilor for this answer before a lease-to-own agreement is signed.
Canadian banks start by considering a person’s employment, their income, credit, and total debts. This helps them to assess someone’s ability to pay which is a good thing given that not doing so is what caused the American subprime mortgage crises that began last year.
The rules do tend to change frequently which makes the knowledge of a mortgage professional even more invaluable. Bad credit and high debts are common enough that it makes good sense to have a professional involved throughout the LTO in order to catch potential problems early. In Ontario, a tenant may also be required to follow a monthly budget and have their credit reviewed once per quarter as a condition of their acceptance into a lease-to-own home.
The services of a mortgage professional or credit councilor are an essential basic and a key part of a Canadian LTO that mustn’t be overlooked. Remember, the goal of any lease-to-own home is to give a tenant the tools to become a home owner sooner. Having enough for a down payment won’t help a tenant qualify for a mortgage in Canada if they have poor credit or a lot of debt.
In other words, a legitimate LTO program must always begin with the end in mind. For Canadians the basics must include having a professional prepare a plan that considers whether the banks will actually approve your mortgage when you’re ready to buy your new home. It could be the difference between owning your home and bitter disappointment.
David-Paul Sip is a successful Canadian real estate investor from Toronto, Ontario. He is the founder of http://www.HomesForRentandMORE.com and specializes in helping couples and families become home owners sooner with lease-to-own homes. David-Paul is also a mentor, public speaker, and community volunteer. You can follow David-Paul on Twitter at http://www.twitter.com/davidpaulsip to learn more about lease-to-own homes in Ontario and LTO investing.
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