Rent-to-own: financing without a bank, but not without cost.

How rent-to-own works for houses and flats

In a rent-to-own purchase of a property, buyer and seller combine two agreements: one about living in the property and one about buying it. Each monthly payment is split into a rent share, which stays with the seller, and a credited share, which is deducted from the purchase price. Whatever is still missing at the end of the rental phase is the remaining purchase price.

In practice there are two basic forms:

• Tenancy with a purchase option. You rent and receive the right to buy the property at a fixed price until a deadline. Whether you buy is your decision. The seller is bound, you are not.
• Purchase in instalments. The purchase agreement is signed straight away, but the price is paid in instalments over several years. The seller remains the owner until the last instalment or until the remaining price is paid. This form is more binding for both sides.

The term Mietkauf is also used for machinery and vehicles, for example when a car is bought this way. Different rules apply there. This article covers houses, flats and plots of land only.

Without a notary, rent-to-own is not valid

A rent-to-own purchase of a property is not a simple tenancy, even if it starts like one. Under § 311b (1) of the German Civil Code, a contract under which one party undertakes to transfer or acquire ownership of a plot of land must be notarised. This applies to a purchase in instalments as well as to a purchase option that is meant to bind the seller.

Without notarisation the purchase agreement is invalid. It only becomes valid once the transfer is actually entered in the land register. For a buyer who pays credited amounts for years, that is a considerable risk. A privately drafted tenancy agreement with the sentence "The tenant may buy the house later" is not enough, not even between relatives or friends.

The notary is more than a formality. The notary sets out rent, credited share, remaining price, deadlines, maintenance and the consequences of payment default in one contract and advises both sides. How notary costs are made up is explained in the guide to notary costs when buying a home.

The priority notice protects your payments

With rent-to-own you pay money for years for a house that does not yet belong to you. What happens if the seller sells, takes on debt or becomes insolvent in that time is decided by an entry in the land register: the priority notice, in German Auflassungsvormerkung.

Under § 883 of the Civil Code, the priority notice secures your claim to ownership, including a future or conditional claim. Dispositions by the seller after the entry are ineffective to the extent that they would defeat this claim. That expressly includes enforcement measures and insolvency administrators. Under § 106 of the Insolvency Code, the holder can still demand the transfer in the event of insolvency.

Two further points belong in the contract. Land charges already registered before the priority notice rank ahead of it. The notary should therefore arrange how the seller's bank releases them by the time ownership is transferred. And a priority notice costs notary and land registry fees. Saving money here is saving in the wrong place.

Worked example: rent-to-own compared with a bank loan

Whether rent-to-own pays off only becomes clear in comparison with bank financing. For this we assume that you pay the same amount per year in both cases and look at how much of the house is still outstanding after ten years. All figures are percentages of today's value of the property, so they can be applied to any price range.

Assumptions: rent-to-own with a purchase price 10 per cent above today's value, monthly payment of 0.5 per cent of the price, of which 60 per cent is credited. Bank loan for 100 per cent of today's value, assumed borrowing rate 3.5 per cent, same annual payment, monthly instalments. Purchase costs not included. ME Finance calculation, rounded.

At the same burden, around 70 per cent of today's value is still outstanding after ten years of rent-to-own, compared with around 63 per cent with the bank loan. The difference comes from two places: the mark-up on the purchase price and the rent share that is not credited. If less is credited, for example half of the payment, 77 per cent is still outstanding after ten years. Even at an assumed interest rate of 4 per cent, the bank loan would stand at around 68 per cent.

What the table does not show: for the bank loan you need the purchase costs from your own funds and a bank that is willing to lend. That is exactly where many people looking for rent-to-own get stuck. And at the end of the rental phase there is the remaining price, which most people then pay through a bank after all. The mortgage calculator works through the bank side with your own figures.

Transfer tax and purchase costs are due earlier than many expect

With rent-to-own, many assume that tax and notary costs only arise on the final purchase. That is true for only one of the two basic forms. Under § 1 (1) No. 1 of the Real Estate Transfer Tax Act, the purchase agreement itself, or any other transaction that creates a claim to transfer of ownership, triggers real estate transfer tax.

• Purchase in instalments: The claim arises with the contract. The tax is due at the start, on the full purchase price, even though you pay it over years.
• Purchase option: As a rule, the tax only arises when you exercise the option and the purchase is concluded.

In Hesse, real estate transfer tax is six per cent. Because it is calculated on the agreed purchase price, with rent-to-own you also pay it on the mark-up the seller charges for the long term. Notary and land registry costs for the contract, the priority notice and the later transfer come on top. Which items arise overall is shown in the guides to purchase costs and to real estate transfer tax in Hesse.

The risks of rent-to-own lie mainly with the buyer

A rent-to-own purchase runs for many years, and a lot can change in that time. Most of the risks lie with the buyer, because the buyer pays before becoming the owner. Four points should be settled before signing:

• Payment default. If the buyer can no longer pay, the seller can usually withdraw. Whether the credited amounts are then returned in full, in part or not at all is set out solely in the contract.
• Maintenance. Buyers often take on repairs during the rental phase, although the house does not yet belong to them. This should be agreed explicitly and reflected in the price.
• Fixed price. The purchase price is fixed at the start. If the market value falls during the rental phase, you still pay the agreed price.
• Remaining price. At the end the outstanding amount has to be paid, usually through a bank. The bank then checks income and creditworthiness as with any other purchase. If you cannot get financing today, you should know why, and whether that will change by then.

If the seller acts as a business, for example a developer or housing company, German consumer credit law may also apply. Under § 506 of the Civil Code, paid financial accommodation granted by a business to a consumer is treated like a consumer loan, and for property the rules on consumer real estate loans apply accordingly. These include information obligations and a right of withdrawal. Whether a specific contract falls under this is clarified by the notary.

For sellers, rent-to-own is a loan to the buyer

From the seller's point of view, rent-to-own is also financing. The seller does not receive the purchase price in one sum but over years, and bears the risk that the buyer defaults during that time. In return the seller asks a higher price and keeps the rent share.

Especially with rent-to-own between private individuals, for example among relatives, this risk is often underestimated. If the buyer defaults, unwinding the deal with a priority notice in the land register is laborious. Until then the seller remains the owner, with property tax, insurance and liability. Anyone who wants to sell without relying on a bank should ask the same question a bank would: can the buyer carry this for the entire term?

Bank financing is often possible after all

Most people look for rent-to-own because they believe they will not get a mortgage: too little equity, self-employment, a previous rejection. Before committing to rent-to-own for many years, it is worth taking a second look at these reasons.

• How much equity banks actually expect, and when financing with little equity works, is explained in the guide to equity in German mortgages.
• Why a rejection usually happens and what can be changed is covered in mortgage rejected.
• There are banks with their own rules for the self-employed and freelancers. More on the page on financing for the self-employed.

And if rent-to-own is still the right route: the remaining price at the end is an ordinary mortgage. The earlier it is planned, the better the credited share, term and remaining price can be aligned with it.

Key takeaways

• With rent-to-own, part of the rent is credited towards the price. You only become the owner with the remaining price.
• The contract must be notarised. Only a priority notice in the land register protects your payments.
• With a purchase in instalments, transfer tax is due at the start, on the full price including the mark-up.
• At the same burden, more is outstanding after ten years than with a bank loan. The seller is paid for providing the financing.
• Most buyers finance the remaining price through a bank. Often that is possible sooner than expected.

ME Finance is not a credit institution and does not offer rent-to-own contracts. We compare offers from more than 500 banks and credit institutions and check with you whether financing is already possible today, or how the remaining price of a rent-to-own purchase can be financed later. We take your key details through the non-binding enquiry.