Rent-to-buy: Nicola Field Pitfalls to watch out for
First home buyers struggling to achieve the great Australian dream risk losing their savings by signing up to a dodgy scheme
High property prices make it tough for first home buyers to secure a decent deposit. The struggle is even harder for renters and buyers with a tarnished credit record. This has left a gap in the market – one filled by so-called black market housing operators spruiking rent-to-buy deals.
Gerard Brody, CEO of the Consumer Action Law Centre, says rent-to-buy deals are pitched as an easy way to buy your own home without a mortgage “but when they come undone we see how complicated and dangerous they really are”. A recent report entitled Fringe Dwellings by the law centre found that these schemes can be financially devastating, with the arrangements often heavily stacked in favour of the vendor.
How they work
Chances are that at some stage you’ve come across handwritten posters offering homes for sale without bank finance. These rent-to-buy schemes, also known as wrapping or lease-option schemes, come under the broad banner of vendor finance, and they can be found advertised on property listing websites as well as general classified sites such as Gumtree, and even dedicated vendor finance sites like buywithoutabank.com.au.
The deals typically work like this. The sale price of the home is agreed at the outset with the buyer paying an upfront fee, often around $10,000 or a percentage of the home’s sale price. The marketing spin is that this payment goes towards building equity in the property. In reality, it secures an option to buy the home at a future date.
The buyer can move in immediately and begins paying rent on the home for a set period, usually four to five years. Part, though not all, of the rent paid comes off the amount owing on the home, and at the end of the set rental period the buyer needs to stump up the balance owing on the property.
Once they’ve moved in, buyers have the freedom (and in some cases are encouraged) to undertake renovations on the property to increase its value and thereby build
equity. The flip side is that buyers are usually also responsible for paying the outgoings associated with owning the home, including repairs and maintenance, building insurance and council rates.
At this point it can sound like an ideal arrangement for home buyers struggling to come up with a reasonable deposit or qualify for bank finance. But there’s a lot that can go wrong, and the law centre has found that many people end up losing their home without any refund of the rent that was supposedly helping to pay off the property. In fact, it says it has seen no examples of successful rent-to-buy deals.
Understand the catches
These schemes are not illegal but most people don’t choose to sell their home this way, so the number of homes offered for sale through rent-to-buy is small. This immediately reduces a home buyer’s choice.
More worrying, these schemes can have a significant impact on the buyer’s hip pocket. The law centre says the sale price of properties is often inflated, reflecting what the seller believes the place may be worth after the rental period ends, and buyers who commit to an excessively high sale price can find it even harder to secure loan finance further down the track.
In the meantime, the regular rent is likely to be far higher than market rent. As a guide, a two-bedroom unit recently advertised for sale through rent-to-buy in the Sydney suburb of Liverpool came with a weekly rent of $560 yet the suburb’s market rent for a two-bedroom apartment is $376. Rent-to-buy spruikers will say that the excess paid over market rent goes toward paying off the home. The trouble is, purchasers have no ownership rights over the property and their name doesn’t appear on the title deeds until the final payment is made. Rather, what they sign up for is an option to buy. This being the case, the renter is protected by tenancy laws but that’s about it. A single missed rent payment can see the sale contract terminated and the tenant/buyer booted out with nothing to show for the extra rent payments or any improvements made to the property.
Moreover, because the buyer’s name doesn’t appear on the property’s title deeds during the rent period, if the vendor is declared bankrupt their creditors can make claims on the property leaving the purchaser facing a serious financial loss. This assumes the vendor actually owns the place. Buyers often have little idea of what is going on behind the scenes, and in one case handled by the Supreme Court of NSW the “vendor” of the rent-to-buy scheme wasn’t even the registered owner of the property.
Finance still required
For the buyer the real clincher can arrive when the end of the rental period rolls around. At this point they need to come up with a bank loan to pay out the vendor, and there is no guarantee that someone who struggled to secure finance several years ago will be approved for a loan when the crunch time comes. Indeed, a lot can happen since the deal was struck. Property values can fall, interest rates may rise, or the buyer’s personal situation can take a turn for the worse, potentially making it even more difficult to secure loan finance.
The Consumer Action Law Centre notes that many rent-to-buy contracts do not give the buyer a right to extend the contract if they can’t come up with the cash. Unlike a bank foreclosure, where the owner receives any surplus from the sale of the property, a buyer who moves out from a rent-to-buy property stands to lose everything paid towards the property. At this point the landlord/vendor can simply re-advertise it and reel in another hapless tenant, having pocketed super-sized returns from the previous tenant. As these types of purchases are not covered by the National Credit Code, the buyer has little legal protection.
Gaps in the law
Rent-to-buy schemes fly under the radar of the mainstream housing industry so it is difficult to know how many people use them. However, Brody says: “What we’re seeing here is the perfect storm. You’ve got struggling Aussies who are told they can finally own their own home. You’ve got an industry operating outside the mainstream property market. And you’ve got a complex legal framework that isn’t adequately protecting hopeful home buyers.”
“These schemes operate on the fringes of the property market and of the law. We need law reform to end the damage they are doing to people’s lives. There are serious gaps and uncertainties in the law when it comes to these deals – people are in a much worse legal position than if they were a renter or a regular home buyer.”
Government solutions
The federal government is said to be considering a government-backed rent-to-buy scheme similar to one available to first home buyers in Britain. Through the UK’s Rentplus arrangement homes are leased to housing associations and made available to low and middle income earners. The homes are let out at 80% of market rent, increasing by 1% plus inflation every year. After five to 20 years tenants can buy their home with a 10% deposit.
There are some lenders who require only 3% to 5% of the purchase price as genuine savings
In March 2017, the Victorian government announced a new co-ownership pilot scheme, HomesVic, targeting first home buyers who are able to meet regular mortgage repayments but unable to save a decent deposit because of rising rental costs. The scheme is due to start in January 2018 with an initial allocation of $50 million over two years. HomesVic will co-purchase up to 400 homes, taking an equity share of up to 25%. By allowing buyers to purchase less than 100% of the property, a small deposit of just 5% is required. Eligible applicants will include couples earning up to $95,000, and singles earning up to $75,000.
Alternative routes
In the meantime, Paul Holland, Mortgage Choice broker in the Sydney suburb of Penrith, says it’s important for home buyers to know there are other avenues to ownership that don’t involve rent-to-buy deals.
“There are lenders who will still accept very small deposits, in some cases as low as 5%,” he says. “In almost all cases, however, buyers generally only need 3% to 5% of the purchase price as genuine savings – that is, money built up over a period of time. The rest of the deposit and purchase costs can come from non-genuine savings such as a cash gift from parents, money from the sale of a vehicle or an inheritance.”
Holland adds that home buyers who are renting will still need a deposit but where it comprises non-genuine savings some lenders waive the genuine savings requirement if the buyer can provide evidence of paying regular rent to a real estate agent.
First home buyers in particular can consider options such as a parental guarantee, which Holland says is becoming more popular, as well as co-buying with like-minded friends or family members.
The situation is harder for buyers with a tarnished credit record. A poor credit record generally calls for a 20% deposit, though Holland says even these buyers can still access a loan through mainstream lenders depending on the reason, type, size and number of defaults. “If the problem is a default payment, it is worth making good with the payment as defaults are something lenders shy away from. Providing a letter of explanation about what happened with the default can also work in a borrower’s favour.”
Having a couple of dents in your credit record can mean paying a higher rate initially but after a few years it’s often possible to refinance to a lower-rate loan. Alternatively, says Holland, “defaults drop off personal credit records after five years so it can be worth waiting until your credit record is squeaky clean to apply for a home loan”.
The key is to get good advice early. Speak with a reputable broker or lender to know what your options are rather than potentially leaving yourself financially skewered with a rent-to-buy option.
A note of caution comes from Holland: “I have encountered a rent-to-buy purchaser who was knocked back for home loan finance when the rent period came to an end. When that happens, the buyer may have few options other than to bail out and lose their money or keep going with above-market rent payments.”