“Rent to Buy” houses – what can go wrong?

Just google “rent to buy” and “win-win” – those phrases seem to just go together!   It just doesn’t always work out that way in reality.

This is not legal advice and the problems listed here may not be relevant to all deals.  If in doubt, please seek legal advice.  If you’re already in trouble, also see here for more advice.

Here I look at examples of rent-to-buy and lease option deals, but can’t find any that add up!

Briefly, the possible downsides for buyers or sellers[1] are:

·         Rent to Buy” house deals are complex.  Borrowers are almost always unable to get a mainstream mortgage (and some investors promote schemes to people who are bankrupt,  or with ‘bad credit’).  It is no surprise that faced with payments that well exceed (sometimes double) rent payments, and obligations to pay rates and maintenance, some of these buyers get into trouble.

·         Buyers can lose tens of thousands of dollars (and sometimes their first home owners grant) within a few years if the deal falls through because they can’t maintain payments.

·         Part of the profit arises from inflating the price of the home.  Some agreements are priced so that unless there are extreme property value increases, the amount owed by the buyer will be greater than the house value for quite some years, thereby ensuring that the buyer will not be able to buy the house in any reasonable time.

·         In some cases the contract may give the buyer as little as two years in which to qualify for finance.  If the price is well above market value, the agreement may be doomed from the start.  This won’t disadvantage the investor/seller, who may retain all monies paid and can advertise the house again.

·         The buyer’s name isn’t on title, making the buyer vulnerable.  A seller can often incur further mortgage debt – but even if the seller has other unpaid debts such as credit card debt, the lender can sell the house through the courts to recover payment.

·         If the seller goes bankrupt, the ‘buyer’ is likely to lose everything and won’t have a claim on the property.

·         Resolving disputes fairly is difficult.  Buyers are often unable to get legal help to dispute such complex agreements.  The complexity of these arrangements often means that tenancy tribunals, and industry ombudsman schemes, can only deal with part of an agreement.  For example a tenancy tribunal may be able to determine a dispute about rent, but not about an option agreement.

·         The terms of the agreements are usually slanted to benefit the investor or seller.

·         The documentation is complex and difficult to understand.  Many buyers don’t get legal or financial advice, and in some cases are discouraged (by sellers or transaction engineers) from getting legal advice or choosing your own lawyer.

·         Where transaction engineers are involved, they may be one of thousands of people who have done a course (for example with Rick Otton) and a very inexperienced person may be making the arrangements between buyers and sellers.

·         Effective selling techniques are used to build trust, and bring about results for the investor.  While most of those in business employ selling techniques, these can increase the risk of detriment to individuals when combined (as they can be here) with complex types of arrangements and pressure to sign or to not get independent advice.   For example, an investor may indicate to a purchaser that there other buyers are competing for the deal (when they’re not) or focus on irrelevant matters (such as what colour the buyer may paint the house, how they might decorate it etc) before disclosing the financial details.  “Building rapport” can help to convince a seller who is in a desperate financial situation to trust the investor when the seller would be better off selling their home in the traditional manner.

·         In some states, a long rental lease (which is sometimes the case in these agreements) may remove a tenant’s rights under residential tenancy laws.

·         Sellers may be told by a ‘transaction engineer’ that the sale is likely to settle in one or two years – without stressing the fact that the sale contract is written up for a much longer period (eg 25 years).  The seller may have other debts or other reasons that he needs the home sold within a few years.  He may not be fully aware that the contract may prevent sale of the home for many years.

There is a more detailed analysis of lease options here.

(a(Added 5/4/14) The intermediary may have no experience in rental or property management.  If the buyer damages the premises, or doesn’t make payments, there may be no-one prepared to help the seller.   I’ve heard from two separate sources about ‘buyers’ using houses for illegal activities – perhaps there is a view that while a “rent to buy” house may require larger upfront payments than a rental property, there is is less chance of there being an experienced estate agent or property manager to monitor the property.    The intermediary may lose interest once problems arise, leaving the seller with much bigger problems than they had when they were initially offered a “helping hand”.    If the seller is in financial difficulty (as is often the case)  the seller may not be able to afford legal help.

[1] There may be risks for the investor/sellers or ‘transaction engineers’ who set up these deals – I just don’t know.  I am focusing on problems for buyers (and some sellers).

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