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How does vendor finance work?


Q Why does vendor finance work?
A By providing what sellers and buyers are looking for!

What are sellers looking for?
To sell a property quickly and easily, for a good price.

What are buyers looking for?
To escape the rental market and buy their own home on affordable terms.
 

The vendor / seller / owner financier provides this solution:

Instead of sending you, the buyer away to find a bank loan to purchase my home, I will be the bank and finance you myself and provide you with a home of your own on affordable terms!

Vendor financiers provide a service which matches and betters what the banking system provides because the seller works with the buyer to tailor a vendor finance solution for the sale to meet the circumstances of both the seller and the buyer.

Vendor financiers provide a personal service which focuses on the buyer’s capability to make regular payments, rather than the banker’s ‘tick the boxes’ approach. Vendor financiers willingly “step in where bankers fear to tread”, by accepting buyers who are self-employed, or with low deposits, or with “black marks” on their credit file (meaning minor blemishes, not bankruptcy).

Vendor financiers tell buyers that they are “the bridge to the banking system”. That is, they encourage buyers to obtain mainstream bank finance in a 2 to 5 year time frame, after the buyer establishes a good track record of making payments (“creditworthiness”), and perhaps builds equity in the home by making home improvements (“sweat equity”).

Vendor financiers are willing to accept the risk of a less-than-bank-perfect buyer because they personally assess the buyer’s commitment and capability to buy, and because they balance the risk they take with an attractive positive cashflow return they will receive from the property.
 

Vendor Finance as an investment strategy

In recent years, vendor finance has become popular in Australia not only as a way of selling properties at a good price, but also as an attractive real estate investment strategy. If we accept that a real estate investment with a superior rate of return and a locked-in capital gain is an attractive strategy, then how does vendor finance deliver on this strategy?

Vendor finance can enhance the cashflow return from a property in the region of 3%, over and above the net percentage rental return from a property. As such, it may turn a negatively geared investment property (a return of 4%) into a positively geared property (a return of 7%), or make a newly purchased investment property cashflow positive from day one!

Note – the way to calculate percentage return on a property is – total the net income (rent received less maintenance, repairs and outgoings) over a year calculated as a percentage of purchase price or value.


There are joint venture partners who are experts in vendor finance who can assist investors and owners to turn negative gearing into positive gearing!

Contact me and I will introduce you to a joint venture partner who can help you vendor finance your property all around Australia and New Zealand. To hear from some joint venture partners view -



 

Can you tell me a little more about the vendor finance strategies?

Instalment Sales are where the owner (the seller or the vendor) sells the property under a Contract for Sale and finances the sale themselves, instead of the buyer needing to use bank finance.

This form of vendor finance is advertised as –

Buy my Home, $X per week, No Banks! Stop renting – start buying!

Instalment Finance has the look, smell and feel of a bank loan. The term is usually 25 or 30 years, the repayments are principal and interest, and the purchaser can pay out the finance at any time by refinancing or by selling the property. The interest rate is generally at the bank low doc loan rate, and will rise and fall in line with rises and falls in the bank rate. The payments are made weekly / fortnightly / monthly by direct debit or by paymaster’s authority.

The main differences between instalment finance and bank finance are –

  • if instalment finance is provided by the owner, the owner retains ownership (the title to the property remains in the seller’s name) until the instalment finance is refinanced or until the property is sold by the purchaser. Solicitors will recommend to a purchaser to lodge a caveat on the title to protect their interest because the title is not in the purchaser’s name; and
     
  • if a bank lends the finance, it needs to take out a mortgage over the property as security for its loan because the ownership of the property (the title) is in the name of the owner, not the bank.

The purchaser using instalment finance has all the advantages and obligations of an owner. The advantages are that the purchaser can move in immediately the Contract is entered into, and is able to make improvements to the property to build up their equity. The obligations are to pay for all maintenance and repairs, and also to reimburse the owner for outgoings such as Council Rates, Water Rates, Strata Levies and Building Insurance Premiums.

Inevitably, purchasers will find it advantageous to refinance after 2 to 5 years with bank finance because they have an established payment track record and the bank loan payments on a standard home loan are cheaper than the instalment finance payments. This is encouraged as soon as the purchasers have 10% or more equity in the home.

This form of vendor finance is also known as a ‘WRAP’ or ‘WRAPPING’, because the payment terms the owner provides mirror the terms of the owner’s own mortgage, and because the owner is permitted to retain their own mortgage over the property.

Deposits are usually paid in cash, but sometimes are part credited by “sweat equity” where a purchaser will renovate the home in a pre-agreed way and will receive a pre-agreed credit for the value of work carried out. Often these properties are advertised as “handyman’s specials”.

The documentation consists of a Standard Contract for Sale which is ‘supercharged’ with an Instalment Payment Schedule and a Licence to Occupy Schedule, and a National Consumer Credit Code Disclosure Statement. Lawyers call it an executory contract, which means that the legal obligations are governed by the contract until settlement (that is, full payment of price) takes place at some time in the future.

Instalment Contracts cannot be used in South Australia.

Learn more about Instalment Contracts in the Instalment Sales tab.
 

Rent to Own is where the purchaser rents for a bit, and agrees to pay for the property at a future date.

This form of vendor finance is advertised as –

Rent to Own, Rent 2 Own, Rent to Buy, Rent now, Buy later pay $X per week, Build a deposit instead of just renting

Rent to Own / Deposit Builder has the look, smell and feel of a buying and renting all at the same time. It has six great attractions for both the landlord/owner and the tenant/buyer -

  1. The property is rented for a long time - usually for 3 years. This is in contrast to a standard residential lease which usually lasts for 6 months, and no more than 12 months.
     
  2. The rent is fixed for the term of the lease ( annual CPI increases are often inserted).
     
  3. The purchaser pays extra money above the rent, and the extra money is paid to build up a deposit. From the tenant’s perspective, they can use the payments to purchase the home, at the agreed price within the agreed time frame. From the owner’s perspective, the extra money creates the situation where the rent plus the extra money could make the property cashflow positive.
     
  4. The purchase price of the property is agreed up front – there is no formula for increasing the price.
     
  5. The purchaser can improve the property, to make it more pleasant to live in, and to make it easier to obtain the finance to purchase the property at the end of the agreed period.
     
  6. If structured as a Contract for Sale, the purchaser reimburses the council rates, water rates, insurance premiums and strata levies for the property. The purchaser is also responsible for repairs and maintenance on the property.

The documentation for the rental is a standard Residential Tenancy Agreement or a Licence Agreement, while the documentation for the sale is a Delayed Settlement Contract. The Contract is structured so that extra money paid is credited against the 10% deposit payable.

Rent to Own contracts cannot be used in South Australia.

Find out more about Rent to Own in the Rent to Own tab.


Deposit Finance is when a vendor finances a deposit, or a shortfall between the amount of loan that an outside lender will advance, the cash deposit at hand, and the purchase price of a property.

This form of vendor finance is advertised as -
Deposit Finance available t.a.p. (t.a.p. = to approved purchasers).

For example, a lender might approve a loan of 80% of the price, the purchaser might have 5% in cash, and so the deposit finance will be 15% of the price. For these purposes, treat stamp duty, loan expenses and legal fees as part of the price. Deposit finance is also known as second mortgage or carry-back finance. It is called second mortgage because it ranks second in line to the first mortgage that the 80% lender takes over the title to the property. It is called a carry-back because the vendor carries it back, which is to say, finances that part of the price.

Deposit Finance is usually put into place for a fixed term of 2, 3 or 5 years, the payments are usually interest only at the same interest rate charged by the external financier, payable monthly, and the interest rate payable is usually fixed. At the end of the fixed term, the Deposit Finance is usually paid out from savings or refinancing, as a lump sum payment.

The documentation for Deposit Finance consists of a Residential Loan Offer, which is compliant with the National Credit Code, plus a Mortgage and a Caveat. Either the Mortgage is registered as a second mortgage over the title to the property, or the Mortgage is left unregistered and a Caveat is registered over the title to the property, as security for payment.

Find out more about Deposit Finance in the Deposit Finance tab.





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