Rather than having a bank or mortgage company lend money, the seller of a house, known as the vendor in property-speak, gets money from the buyer with whatever terms have been negotiated.
Andrew Allentuck, Financial Post
Vendor financing, one of the less well-known ways to buy a home, is one of the most flexible means to pay for it.
Rather than having a bank or mortgage company lend money, the seller of the house, known as the vendor in property-speak, gets money from the buyer with whatever terms have been negotiated.
The deal, sometimes called vendor take back finance, may include barter, such as a swap of assets with or without additional cash. For a homeowner willing to defer payment over time or to include a property swap, such as the buyer’s prized antique car or sailboat, as part of the purchase price, it’s a way to get the deal done.
“It all depends on the purchaser’s needs and the vendor’s motivation,” explains Jim Murphy, president of the Canadian Association of Accredited Mortgage Professionals in Toronto. “Frankly, these deals are uncommon these days, but in a tougher real estate market, you would see more of them.”
In residential real estate sales, vendor financing deals are rare, says Kevin Jaques, whose Jaques Law Office in Regina, Sask., does them, though not often. “If I am trying to sell a place, I just want to get my money and get out,” he explains. “I don’t want the difficulties of worrying about getting paid and enforcing an agreement if I am not paid.”
But there are special situations that make vendor financing helpful and even essential to making a sale. If a buyer has not established a credit history and a bank won’t lend at a reasonable rate of interest or perhaps at all, vendor financing may be required. “The vendor will want a big deposit to cover costs of foreclosure if the deal does not work out,” Mr. Jaques cautions.
Vendor financing can also be used when the vendor knows the buyer well, as would be the case of a family member such as a child who buys a property form a parent.
Becoming the lender in a sale of one’s home can increase the risks that the vendor takes in the deal. If the buyer does not pay on time after title has been transferred to him, getting the home back may take years of litigation. One of the best protections the vendor can have is to make the deal an agreement for sale. Unlike a mortgage take back in which title is transferred to the purchaser who then grants a mortgage back to the vendor, the agreement for sale does not transfer title to the property until all payments have been made and no further funds are owed. Until the title is transferred when all payments have been made, the buyer has limited rights over the property, which remains the vendor’s.
Vendor financing may be worth the trouble if the mortgage pays appreciably more than bank deposits or GICs or if tax advantages add to the return. If the vendor has no other investment plan for the money from a sale other than put it into a bank deposit at low interest rates, he can write a loan against property he already knows.
In commercial real estate sales, where mortgages tend to have higher interest rates than residential mortgages, vendor financing is more common. And where there is a taxable capital gain, it makes sense to consider vendor financing.
If a person sells a second home, perhaps a vacation cottage, then the difference between the sale price and cost (which includes improvements) will be a taxable capital gain. If the sale is financed by a conventional mortgage, the vendor is paid immediately at the closing and the gain is taxed in the year it is realized. But if the vendor finances the sale, then the deal can be structured to distribute the capital gain exclusive of interest over a maximum of five years. Interest is taxable as received, which could be a period as long as the amortization of as much as 25 or 30 years. The accounting details are complex, but the result of distributing the capital gain over as much as five years is lower tax each year and the possibility of putting gains through the tax process at a lower overall rate than if the sale occurs in a period during which the taxpayer is at his or her highest income and tax bracket, Mr. Doer notes.
A final word: vendor take back mortgages are instruments in which the rights and responsibilities of each party need to be spelled out. As well, the costs of the deal – the lawyers’ bills, surveys, etc. – can be shifted to the buyer by agreement. “A private vendor should get the purchaser to pick up the legal costs,” Mr. Jaques says.
Vendor financing deals are best left to the wordsmithing of lawyers who know the field. Protecting a deal in which a family’s potentially largest asset will be transferred is worth the legal fees, perhaps a few hundred or a few thousand dollars, depending on the value of the deal and the jurisdiction.
“The vendor has to check out the buyer very closely to ensure that he or she has the ability to handle his obligations,” Mr. Murphy cautions. The vendor has to be satisfied that buyer can carry his responsibilities for as long as the financing agreement is in place. Vendor finance exposes the seller to problems not involved in a sale handled by a bank or other conventional lender. In an economic sense, the higher risk justifies the higher reward a vendor financing deal may generate.
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