Ins and outs of the vendor take-back mortgage

by 27 Aug 2012

Brokers Dalia Barsoum and Enza Venuto explain the pros and cons of using a vendor take-back mortgage.

Whether you are a starter or veteran investor, mastering the ins and outs of financing and getting the right advice is crucial to your continued success, especially when it comes to a vendor take-back mortgage options.

We have seen a tightening in the lending guidelines and they are expected to continue tightening, especially of the economic situation changes. We have seen amortizations drop from 40 years to (25) years in most cases, tighter rules for buying as self-employed, especially if you don’t show much income on your tax returns, as well the increase in down payment requirements over the years for rental properties.

 

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The good news is that despite the tightening in guidelines, you can still buy and benefit from investing in real estate. It just means that you may now have to broaden the pool of lenders and financing strategies you deal with. It may also mean that there would be some increase in the cost of doing business.

In this issue, we discuss one of the key financing strategies that investors can tap into for lowering their out-of-pocket financing expenses and to save time: the Vendor Take-Back Mortgage.
 

What Is A Vendor Take-Back Mortgage?
A VTB or Vendor Take-Back Mortgage is when the seller (vendor) of a property provides you with some or all the mortgage financing for purchasing his/her property. This type of financing is more common on commercial properties (including multi-residential) however, you can tap into this strategy on residential purchases. A vendor take-back mortgage can also entail the seller covering one or more of your closing costs such as land transfer tax, appraisal, survey or application fees.
 

Why Consider A Vendor Take-Back Mortgage?
There are many reasons why seller-arranged financing may be attractive to you as a buyer:

1. Buying a distressed property. If you are a flipper or looking to buy distressed properties with the mindset of improving/renovating to increase value then a vendor take-back mortgage may come in handy, simply because some lenders may shy away from lending against such a property or may lend at a whopping interest rate. When dealing with distressed properties, it is often beneficial that you finance your purchase through a combination of a vendor take-back mortgage, line of credit, or your own cash, and then approach a lender once you have brought the property to a certain standard.
 

2. You are unable to obtain financing through the standard lending sources. Qualifying for a vendor take-back mortgage is a matter of negotiating one with the seller while getting a mortgage requires you to qualify with the lender. If your financing application got declined and you have exhausted your sources, you may be able to finance your purchase through the seller. Your ability to negotiate a vendor take-back mortgage would depend on how motivated the seller is and his willingness to continue to tie his capital onto the property.
 

3. Increase Your Return on Investment. Assume you have $50,000 in down payment funds to buy your next investment property. In today’s world, this is a 20 per cent down payment for a $250,000 purchase.  

If you were able to arrange your first mortgage financing on this property for 80 per cent of the value, so your first mortgage would be $200,000. If you are able to arrange with the seller a vendor take-back mortgage for 10 pre cent of the purchase – which is $25,000 - then you have effectively lowered your down payment for this property to $25,000 and, as a result, have boosted your return on investment due to the lower cash outlay.
 

4. Buy a larger property with the same amount of funds or less. As per the above example, you can buy a $250,000 property with $50,000 in down payment funds. With the same amount of funds, you can buy a $500,000 property if you were able to arrange a vendor take-back mortgage (your first mortgage) for 90 per cent of the value.
 

5. Save on the costs and time associated with traditional financing. There are various costs associated with financing a property. Those costs are typically much higher in commercial properties and include, but are not limited to, the following: appraisal, survey, lender fees, environmental analysis fees and mortgage insurer fees. In addition to the costs, the process of getting approved for a loan may be lengthy – depending on the complexity of the deal – and often require providing the lender with one or more support documents such as: income and employment verification, details about your existing property holdings, credit, bank statements and tax statement. A vendor take-back mortgage saves you the time and costs associated with getting approved as you are dealing directly with the seller.

It is also worth noting that with a vendor take-back mortgage, generally there isn’t a penalty for pre-paying the mortgage before the end of the term while with traditional lenders such as banks, for example, you will incur a penalty for prepaying the mortgage prior to the end of the term.
 

6. You can afford to pay more for the property. By negotiating a vendor take-back mortgage with favourable interest and terms, you may be able to offer the seller a higher price for their property making your offer more attractive.
 

What Is The Maximum Vendor Take-Back Mortgage That You Can Get From The Seller?
If you are negotiating a vendor take-back mortgage as a first mortgage, then the loan to value (the ratio of how much the seller is loaning you to the purchase price) is a function of what you negotiate with the seller. We have seen buyers able to arrange a vendor take-back First Mortgage as a high as 90 per cent of the price at which they are buying the property.

If you are arranging a vendor take-back mortgage in a second position, meaning that you are going to an institution for your first mortgage, then the max you can use in a vendor take-back mortgage is 10 per cent of the purchase price.
 

Do Lenders Allow Vendor Take-Back Mortgages?
Not all lenders allow vendor take-back mortgages. Your lending advisor would be able to assist you in placing your deal with the right lenders that support this strategy. If you are planning on using a VTB for a particular deal, it is important to disclose this information to your lending advisor.
 


What Is The Interest Rate and Terms Of A Vendor Take-Back Mortgage?
The interest rate and terms on the VTB are negotiable. In most cases, however, the seller will charge you an interest rate higher than what you would typically get through your bank. This is reflective of the higher risks that the lender is willing to accept. The terms on a VTB can vary from interest-only payments with one balloon payment at the end of the term, or interest and principal payments.
 

Why Would The Seller Agree To Such Arrangement?
The advantages of a VTB are many to the seller, including:

1. Monthly Cash Flow. A VTB provides the seller with monthly, consistent money flow after the property sells. Some sellers are likely to charge higher than market interest rates on their loans, enhancing their overall returns and ongoing money flow.

2. Obtaining a higher price for their property. A seller who is providing a VTB at attractive terms can demand a higher price for their property.

3. Deferring taxes. Instead of getting taxed on the full capital gains from selling his/her investment property, the seller can defer the taxes payable on some of those capital gains over a period of five years by arranging a vendor take-back mortgage.  

4. Avoiding pre-payment penalties on existing locked-in loans. If the property has a locked-in loan, the seller can sell without having to negotiate with the lender for a higher loan amount or permission to assign or repay the loan; saving the seller time and money.

5. Selling in a slow market. Offering a VTB in a stagnant market offers an extra incentive to buyers. It also helps the seller successfully market a hard to sell property.
 

What Are The Risks Of Vendor Take-Back Mortgages?
Despite its advantages, a VTB mortgage should be entered into with caution. It is complicated and you should always consult with a real estate lawyer to review all documentation and for due diligence. From a seller’s point of view, he/she is dealing with the risk of default. From a buyer’s point of view, he/she may find themselves having to pay off the VTB mortgage in a lump sum if the seller dies, goes bankrupt, or needs to liquidate his estate.

Dalia Barsoum, MBA, FICB and Enza Venuto, AMP, CMP and are lending advisors with CENTUM Streetwise Mortgages #11789 and real estate investors with over 48 years of combined lending, financial and investment experience. The team provides advisory services and lending solutions tailored to Real Estate investors and different investment strategies (www.streetwisemortgages.com).

 

Looking for more in-depth information and analysis to help your clients succeed and allow you to grow your mortgage business? Subscribe to Canadian Real Estate Wealth magazine now!

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