Hire-purchase and How It Works

Rent-to-own: An option for renters who want to become homeowners but have little or no down payment.

The principle behind rent-to-own is actually simple: First, a lease agreement is signed; later, ownership of the rental property is transferred to the tenant. The purchase price for the apartment or house is agreed upon when the lease is signed. While you’re living in the apartment or house, you pay rent that already includes a savings component toward the future purchase. Upon purchase, the amount saved up to that point is applied toward the purchase price. The seller retains a portion of the monthly payment as rent.

Thus, rent-to-own represents an alternative to traditional real estate financing for many tenants who wish to own their own home but can contribute little or no down payment. Nevertheless, it is important to do thorough research beforehand: Hidden costs and inflated prices can make a rent-to-own arrangement more expensive than purchasing a property with a mortgage.

First of all, the rent-to-own buyer and seller must agree on the rent amount and the purchase price. Both are finalized when the rent-to-own agreement is signed. This agreement is typically entered into for a term of 10 to 20 years and must be notarized, as is the case with all real estate purchases. This involves certain costs. In the case of a purchase option (see below), an entry must also be made in the land registry, which likewise requires the services of a notary.

The landlord/seller retains a portion of the rent as rent payments, while the other portion is applied toward the purchase price when the property is eventually purchased. However, the rent-to-own agreement may also stipulate that the entire monthly rent be applied toward the purchase price. In addition, in most cases, a down payment of approximately 20 percent of the purchase price must be made.

Once the lease term has expired, the tenant may purchase the property at its remaining residual value. If no residual value was agreed upon, the property is paid off through higher rent payments or a longer lease term—and then automatically transfers to the buyer at the end of the lease term. However, if you, as the tenant, encounter financial difficulties, the seller has the right to terminate the lease agreement under the terms of Section 543(2)(3) of the German Civil Code (BGB). In that case, not only would the amounts you have already paid be forfeited, but you would also no longer be able to purchase the property. Furthermore, the landlord/seller could file a claim for damages against you for the loss of rent.

First renting a house or apartment, then buying it: This approach to buying real estate sounds appealing to many at first, especially since part of the rent goes directly toward investing in the home, and in the end, only the remaining balance needs to be paid. But upon closer inspection, additional costs may come to light. Furthermore, there are hardly any financial assistance options available for this model.

• Low down payment requirement:

  Buying a home through a rent-to-own arrangement is possible even with a low income; there’s no need to take out a bank loan. The first step is simply to sign a lease. A rent-to-own arrangement would enable young and low-income families—who would be unable to contribute any down payment in a “traditional” home purchase—to buy a home relatively early on.

• The rent remains stable:

  Unless increases are contractually agreed upon, the monthly payment remains unchanged for the entire term of the rent-to-own agreement. This means buyers are unaffected by changes in interest rates and rent prices. In addition, they can directly benefit from rising real estate prices—a benefit that would otherwise accrue only to landlords. The rent-to-own payments made over a specified period are fully credited toward the purchase price. This gives rent-to-own buyers planning certainty regarding their housing costs.

• Wealth Accumulation and Retirement Planning:

  Rent-to-own buyers are enabled to build the capital necessary for their retirement planning. Upon purchasing the property, economic ownership immediately transfers to the buyers. From that point on, they hold assets that can further increase their retirement income in later life by converting them into a life annuity. Alternatively, the assets can also be used to finance potential long-term care needs, since statutory long-term care insurance provides only partial coverage and the remaining costs must be financed privately. An appropriate owner-occupied property is also protected from sale should the owner need to claim benefits under the basic income security program.

• Contract Transfer to Third Parties Possible:

  In rent-to-own arrangements, it can be agreed that the contract is transferable to third parties. In such cases, any rent paid will be credited to the third party, thereby transferring all rights and obligations.

• Option to Purchase:

  Co-ops often also offer what is known as an option to purchase, whereby the lease agreement merely grants the option to purchase the property. Typically, a period of up to 25 years is granted, after which the property can be purchased at a fixed price. There is therefore no obligation to purchase the property; ultimately, the purchase can also be declined.

• Limited selection:

  Rent-to-own options are rarely offered, so the selection of properties is significantly smaller. These are often from private sellers, but there are also offers from housing cooperatives and developers.

• No prime properties:

  Houses and apartments offered for rent-to-own are often located in less-than-ideal areas or are not in perfect condition. Since these properties are difficult to sell, many sellers try to offload their real estate this way.

• Bank loans are usually more affordable:

  The financial terms are usually less favorable than with a bank loan because the rent is higher than the local market rate and additional costs, such as closing fees, apply.

• Potential Additional Costs:

  You bear higher renovation and modernization costs than regular tenants, since the property becomes your economic property as soon as you sign the purchase agreement. You must save up the money for such measures separately and, if necessary, pay a portion of it to the landlord.

• Right to have a say:

  You will not have a say—for example, regarding renovations—until you have paid the full purchase price and are thus legally considered the owner. However, this does not apply if you have contractually secured the right to have a say in your favor.

• No government subsidies:

  You may be eligible for a government subsidy from KfW only if you undertake a modernization project.

• Consequences of Payment Difficulties:

  If you are unable to meet your payment obligations, you have no right to recover the money you have paid so far. In that case, you would lose not only the property but also the money you have already paid. Additionally, the seller may file a claim for damages against you. The rent-to-own agreement specifies exactly when you are considered to be in default and the notice period required to terminate the contract.

• Risk of insolvency:

  If the seller becomes insolvent, the money is also lost. You can specify in the contract how the amount already paid should be handled in such a case. It is also possible to have yourself registered as a potential owner in the land registry with a so-called “pre-notation of transfer.” This prevents the landlord from selling or encumbering the property again, allowing you to secure the right of first refusal.

A rent-to-own arrangement can therefore prove to be riskier and more expensive than a “normal” real estate purchase. For this reason, you should carefully assess whether the advantages outweigh the disadvantages.