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Deposit Finance


Deposit Finance is where a seller ‘tops up’ a purchaser’s funds to cover a ‘shortfall’ between the loan advance the purchaser is able to obtain and the cash they have available to pay the price payable to purchase a property or to pay out vendor finance

Basic Structure

  • To set up the Deposit Finance form of vendor finance, the buyer must qualify for a bank loan. The bank loan might be ‘low doc’ which is up to 80% of the value of the property, or 85% or 90%, or for commercial property, 70%. The bank will take a first mortgage over the property as security for the loan. The buyer’s bank must not object to the Deposit Finance – buyer’s banks do not normally object so long as they lend no more than 80% of the value / price.
     
  • The Deposit Finance is documented by a Loan Offer, a Mortgage and a Caveat, which are standard loan documentation used by providers of Second Mortgages. Usually the interest rate will be the same, or similar to the buyer’s loan with the bank. But the term of this vendor finance will be shorter – and the instalments will be interest only, or principal and interest, with a balloon payment at the end of the 2, 3 or 5 year term.

Illustration

A property is advertised for sale at $250,000. A The seller offers to assist the buyer to pay a 20% deposit of $50,000, by the seller giving deposit finance, with the remaining 80% of the price of $200,000 loaned by an external financier. The buyer pays interest only of $76.92 per week on the deposit finance, calculated at 8% per annum on $50,000, and repays the $50,000 at the end of 3 or 5 years out of savings or external financing. Alternatively, the buyer pays instalments of principal and interest of a higher amount than $76.92 per week, and pays out the amount outstanding at the end of 5 years. This illustration is a deposit finance form of vendor finance, which is used to fund the payment of the deposit, documented by a loan offer and a mortgage.

How does Deposit Finance work for owners and investors?

  • Owners and investors are able to offer Deposit Finance to buyers who qualify for a bank loan to pay most of the price, but for some reason or other cannot raise enough deposit.
     
  • Owners and investors who offer vendor finance by means of Deposit Finance, offer buyers the opportunity to borrow the part of the deposit that they have not saved, to buy the property.
     
  • Owners and investors selling with Deposit Finance transfer the legal title to the property to the buyer. Therefore the buyer’s obligation to repay the Deposit Finance needs to be secured over the property. For this reason, the owner and investor takes a mortgage security over the property to secure the Deposit Finance, which because it ranks after the first mortgage security that the bank holds, is called a second mortgage security. This is acceptable to the sellers because the amount financed is relatively smaller than the first mortgage, and should substantially represent the premium above the cash price for the property.

How does Deposit Finance work for buyers?

  • If the buyer’s needs and indeed desires are to buy a home and be able to move in straight away, and all they lack is enough deposit, then a House for Sale – Deposit Finance available advertisement will appeal to the buyer.
     
  • In this case, the buyer has chosen the form of vendor finance known as Deposit Finance. Deposit Finance is also known as a Second Mortgage Carry-Back. Deposit Finance is recognised as legally valid throughout Australian and New Zealand.
     
  • A buyer who is suitable for the Deposit Finance form of vendor finance will be ready to buy the house – ready in every way including being able to qualify for a bank loan straight away. All that stands between them and the house is that they do not have enough deposit. The seller is willing to bridge the gap between the small amount of deposit the buyer has, and the amount that the bank is willing to lend. The gap is bridged as a vendor loan. And that is why it is called Deposit Finance.

The seven things you must know about Deposit Finance

  1. The owner sells the property, and transfers the title to the purchaser, a bank or similar financer finances 80%+ of the price, and the owner finances the “deposit” of between 5% - 20%.
     
  2. Deposit Finance is used to bridge the gap between the upfront deposit paid by the purchaser and the bank finance.
     
  3. Deposit Finance is documented by a mortgage, which is similar to the bank mortgage except that:
    - it is usually a term of 3 to 5 years not 30 years
    - interest payments are made monthly, with the principal paid at the end
    - the interest rate is often the same as the bank rate and is often fixed
     
  4. Direct debit or paymaster authorities are put in place to make the monthly payments.
     
  5. The mortgage can be registered as a second ranking mortgage after the bank mortgage (which ranks first) or can be secured by a registering a Caveat.
     
  6. Deposit Finance is generally known as Second Mortgage (Carry-back Finance).
     
  7. Deposit Finance useful to finance shortfalls on cash outs of Instalment Contracts, and finance shortfalls at the end of Rent to Owns.

Structure, documentation and risks in selling with Deposit Finance

Usual Structure:

  • finance from profit (80/20 rule)
  • adopt bank interest rates
  • interest only or P + I with balloon
  • term (usually 3 or 5 years)

Documentation:

  • clause in Contract for Sale or Loan Offer
  • mortgage (and Caveat)

Risks:

  • enforcement options limited to debt
  • delays in payment
  • shortfall on sale
  • mortgage insurance
  • bank loan requirements

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