A vendor take-back mortgage is not something the common home buyer or even seller probably has heard about. It is something that pops up a lot more in the real estate investment world, but in the right circumstances, it can prove beneficial to both buyers and sellers.
Essentially, the seller (vendor) becomes the lender for the buyer. The vendor take-back mortgage provides an option when traditional mortgage setups are not an option, or when the seller wishes to offer an incentive to a buyer. Although this might not sound like an ideal solution, there are some circumstances when both buyers and sellers might consider taking advantage of the vendor take-back mortgage.
What is a Vendor Take-Back Mortgage?
The vendor take-back mortgage allows the seller of the home to lend money to the buyer for the purchase of their own property. The property has to be owned outright by the seller, meaning there can’t be a mortgage on the home at the time of selling.
The buyer is still required to make regular payments to the seller as they would with any other lender. The interest rate is set by the seller and agreed to by the buyer. However, it is generally at a higher interest rate than one would receive with a more traditional mortgage.
The amount of money provided to the buyer varies from enough to cover closing costs or transfer tax to more substantial amounts to cover the down payment or a portion of the mortgage.
The Vendor Take-Back Mortgage Revival
Vendor take-back mortgages have made their way back into the residential lending scene due to changes in the market and more stress put on buyers. It’s harder to acquire a mortgage because it’s harder to save for a down payment.
In order to get access to mortgages, buyers are looking for different ways to get their down payments. Both sellers and real estate agents have learned more about vendor take-back mortgages and are able to present them to buyers as a viable option to help them buy their dream homes. In turn, it also helps sellers get their houses off the market.
Why Consider a Vendor Take-Back Mortgage?
The vendor take-back mortgage is not the ideal lending situation for the average transaction. Instead, it’s used in specific situations where there are either market challenges for the seller or credit challenges for the buyer.
One of the most common scenarios is during a buyer’s market. High inventory means lots of competition, putting a seller at a disadvantage. As a way to entice buyers to consider their property over the hundreds of other options available, a seller can offer to provide funding to a buyer who might not otherwise have access to the funds required to make an offer.
A vendor take-back mortgage gets the seller’s home off the market while helping the buyer make a purchase that their finances might not have allowed when going the more traditional route.
In the case of poor credit, a buyer who is interested in the home can benefit from the vendor take-back mortgage if the seller is willing to assist them financially. That is a win-win situation. For the seller, it isn’t about the interest only. They also get the house off their hands while the buyer gets to purchase a home that their current credit would have prevented.
In both scenarios, the seller also has the added benefit of increased cash flow from the interest.
The Investor Vendor Take-Back Mortgage Advantage
Despite these two housing market scenarios, a vendor take-back mortgage is a tool used primarily for investors and commercial properties. Sellers who own properties outright can face some hefty capital gains taxes when they sell. A vendor take-back mortgage can help defer capital gains from the purchase price, resulting in impressive tax benefits for the seller.
The vendor take-back mortgage allows the seller to spread their capital gains out over the period the loan is being paid back, making the taxes far more manageable. They also benefit by generating monthly income from the mortgage payments.
As with the house purchase example, for investors with poor credit, the vendor take-back mortgage provides a short-term financing solution until something better comes along from a mortgage lender. As well, the buyer can work on building their credit by paying back the vendor.
A buyer can also build up equity in the property and use that to obtain a better setup with a more appealing mortgage rate.
Vendor Take-Back Mortgage Seller Considerations
As good as it sounds, the vendor take-back mortgage does come with some warnings to sellers. First, keep in mind the vendor take-back mortgage is basically like a second mortgage. Although as the seller you can gain in a bad market, or when you want to offload your house quickly, you could be faced with a buyer who is not willing or able to make their mortgage payments. You’re still part owner of the home, so when this happens, the payments can fall back on you for the balance of the sales price.
It takes money to work with an experienced lawyer who can draw up an agreement to protect you against loan defaults. That is a must since if the buyer defaults, the loan is at risk and so are your finances. As well, it’s a costly process to file for foreclosure.
Vendor Take-Back Mortgage Buyer Considerations
Depending on the vendor take-back mortgage setup, you’re going to have two loans to pay back. Often, buyers are tempted by the vendor take-back mortgage to help provide the down payment to secure a mortgage from a bank. In the case of a conventional mortgage, you pay the down payment, and the bank pays the balance. You then make mortgage payments for the balance.
In the case of a vendor take-back mortgage, you might be given a portion or all of your down payment by the seller, you then pay the bank, and they transfer the funds to pay the balance of the purchase. You now have to begin paying back the seller for the down payment and the bank their mortgage payments.
You have to calculate these monthly payments based on the agreed-upon payment schedule and interest to make sure that when combined, you can afford the payment required.
Benefits of the Vendor Take-Back Mortgage
The vendor take-back mortgage offers three main benefits to the seller:
- You can sell your home faster.
- You can generate extra income from the interest.
- You can reduce the amount of taxes on capital gains.
For the buyer, the vendor take-back mortgage provides an additional type of financing option when you’re facing down payment or credit challenges.
Although taking advantage of the vendor take-back mortgage is not for everyone, it does offer a lesser-known option for arranged financing.