Vendors Helping A Buyer Purchase
While mortgage interest rates are at an all-time low in Alberta, in recent years, lenders are tightening their lending guidelines. They often demand higher down payments and more robust qualification processes for the self-employed or first-time home buyers. One common creative financing strategy is a vendor take back mortgage (“VTB”). Another name for a Vendor take back mortgage is vendor financing. A VTB is a unique type of mortgage in the residential and commercial property lending landscape that may prove beneficial to buyers and sellers in a slow market.
VTBs are often used in situations where sellers experience difficulty selling their home, or buyers are unable to secure financing through traditional lenders. VTBs make home ownership available to those who would not otherwise be eligible, including young people, those with limited credit history, or recently-discharged bankrupts. The real estate lawyers at Kahane Law Office in Calgary help with vendor take back mortgages.
What Is A Vendor Take Back Mortgage?
In vendor take back mortgages, the seller acts as the bank to the buyer. A VTB is a loan provided by the seller to the buyer to facilitate the sale of the property. It is advantageous for the buyer as he or she may be able to purchase a home above the bank-determined financing limit, and the seller can sell his or her property with the added benefit of increasing cash flow from the interest. In particular, VTBs are common among investors who purchase commercial properties.
In VTBs, the parties agree to an interest rate which is generally higher than what one would receive with a traditional mortgage. Much like a standard mortgage, the buyer makes regular payments to the seller. The amount of funds provided under the VTB can range from enough to cover closing costs to higher amounts that cover a portion of the mortgage. This type of financing is a secured debt.
How Vendor Take Back Mortgages Different From Conventional Mortgages?
In general, with conventional mortgages, buyers provide a cash down payment and the banks transfer the remaining amount of the purchase price. Until you fully pay back the amount borrowed, the bank owns a percentage of your home proportionate to the mortgaged amount.
If you obtain a VTB in addition to a conventional mortgage, you must pay the down payment in cash. However, rather than paying the entire down payment yourself, the seller loans you a portion or all of the down payment in the form equity secured by the VTB. The bank then transfer the remaining mortgaged amount for the purchase. In this case, you have two loans, one from the bank, and one from the seller. Alternatively, some buyers obtain vendor take back mortgages as the primary source of financing.
Benefits Of Vendor Take Back Mortgages?
For sellers, there are three main benefits for vendor take back mortgages, namely, sellers can:
- Sell their property faster by offering a VTB as an incentive to purchase, even in a market downturn;
- Generate additional revenue from the interest; and
- Lessen the amount of capital gains taxes because the seller receives sale proceeds over several fiscal years.
For buyers, vendor take back mortgages offer:
- An additional type of financing option when faced with credit challenges or when purchasing a distressed property;
- The flexibility of negotiating terms they may not be able to obtain with traditional lenders, including lower interest rates, and the ability to make interest only payments with a lump sum payment at the end of the term;
- The ability to pay off the VTB prior to the end of term without incurring a penalty; and lastly
- Lower down payments (meaning higher return on investment).
What Interest Rate Should Borrowers Expect to Pay?
Ultimately, the seller sets the interest rate taking into consideration the amount of financing required. However, as a seller, expect to pay higher interest rates if a VTB is a second-position mortgage designed to supplement a bank mortgage. Other times vendors offer vendor take back mortgages to entice a buyer. In these cases, the interest rate may be lower than normal.
Risks For Sellers
While VTBs have various benefits, sellers should also be aware of the risks. From a seller’s perspective, you may be faced with a buyer who is unable to make their mortgage payments. Most buyers already have a primary source of funding from their bank. This means the registration of the VTB as a secondary financial encumbrance against the property. If the bank holds a first mortgage and the buyer defaults on the vendor financing, the seller risks losing their investment.
Additionally, VTBs may heighten a buyer’s risk of foreclosure. As buyers are able to take out more financing than the amount they are qualified for, buyers must ensure they have budgeted to make sufficient monthly payments.
Risks For Buyers
From buyers’ perspective, if a seller passes away, declares bankruptcy or liquidates his or her estate, buyers may be required to pay off vendor take back mortgages in full immediately. Further, a buyer should consider their exit strategy. If a buyer wishes to pay off a VTB and secure traditional financing in the future, speak with a lending adviser prior to obtaining a VTB to learn if this is possible. If the property is in poor shape and a lender is not willing to finance the property in its current state, you may not be able to finance the home with a traditional lender.
Help With Obtaining Vendor Financing
Before obtaining any vendor take back mortgages, it is important to consult with a lawyer. You should be fully aware of your contract rights and obligations under the VTB agreement. For sellers, we review all documents in relation to the VTB to confirm that your interests are protected. With buyers, we review the terms of the VTB with you. For example, this includes the loan amount, term, amortization period, interest rate and amount of payments. In addition, we help you understand the risks you face before signing a VTB. Connect today at 403-225-8810 locally in Calgary, Alberta, toll-free at 1-877-225-8817 or email us here directly.