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.
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 -
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.
The rent is fixed for the term of the lease ( annual
CPI increases are often inserted).
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.
The purchase price of the property is agreed up
front – there is no formula for increasing the price.
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.
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.
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.
