The return of the vendor take-back mortgage?

If you’ve never heard of the vendor take-back mortgage (VTB), it’s probably because you’re not in a housing market that supports it. But it does have some benefits to buyers, sellers, and investors, if done right.

What it is

With a VTB, the vendor – the seller – essentially becomes the lender. The seller lends the buyer money to go toward the purchase of the home, and the buyer then repays the seller over time with an agreed-upon interest rate that’s generally higher than their normal mortgage rate but lower than borrowing with a private lender. A VTB can only occur if the seller owns their property outright; you can’t do it if you’re trying to sell a property and currently have a mortgage on it.  The amount can just be enough for closing, a portion of the down payment, or in some instances, a large portion of the mortgage itself.

Let’s say that a buyer doesn’t have enough for the minimum down payment on a property – 20 per cent down, in the case of a property that’s $1 million or more or an investment property. The vendor agrees to front the buyer enough cash to help them meet that requirement as stipulated by the lender. If a buyer doesn’t have enough for a minimum down payment, though, then the VTB can be a bit of a catch-22; borrowers don’t have enough money for the minimum down payment required, but their mortgage lender still wants to see enough money upfront to know that they’re shouldering some of the risk.

“They won’t allow them to be 100 per cent financed, so to speak; five per cent from the vendor and they have no money in it themselves. They have to have some amount of money in there,” says mortgage broker Pauline Tonkin. She says that the amount of money lenders like to see when using a VTB varies, but that based on the strictness of guidelines right now, lenders like to see up to 10 per cent of a buyer’s own money, just to show that they have some skin in the game.

While a VTB and a primary mortgage are two separate agreements, each one is conditional on the other.

Why it works

The VTB has been flying under the radar in recent years because of lending conditions.

“A vendor take-bank only works if you have a motivated seller. It’s supply and demand. So when there’s more buyers than sellers, or sellers than buyers, it’s gonna change the dynamic,” says mortgage broker Claire Drage. “Having said that, though, there’s many circumstances when a vendor take-back could be a great option for both the seller and the buyer, but no one’s talking about it unless you have a creative mortgage broker or a realtor that knows anything about them.”

The VTB option really only works in certain situations. The first being a buyer’s market, where there are plenty of homes on the market to buy and sellers are having a difficult time selling their homes, and realtors are having a difficult time shifting their inventory. Rather than a buyer waiting a longer period of time to save money for a down payment, a seller can just agree to help them out with that portion of the sale in order to get their home off the market. Another instance is if a seller has a buyer for a property but they have poor credit. In that case, the seller would rather deal with the buyer in order to help them sell the property rather than wait for another buyer.

If all goes well and the buyer repays the seller on schedule as agreed, then the seller ends up the winner; they eventually end up with the money they loaned in addition to the interest accrued, and they also benefit from having a monthly source of revenue coming from the repayments.

Investor perspective

Although it is sometimes used in a residential capacity in the instances mentioned, the VTB is primarily a tool for investors.

If the seller owns an investment property outright, Drage explains, "they might be dinged really heavily with a large capital gains tax, depending on their income bracket. Sometimes a vendor take-back either all or in part can create those deferred capital gains. It can actually have huge tax benefits for the vendor and create a monthly income for the vendor."

Another reason that you may consider a VTB if you're an investor is if you're looking for a short-term solution. So if you're repairing your credit or renovating the property, you can use VTB for a brief period of time, and then either be in a better position as a borrower to get a better deal from a lender or have enough equity in the home to take advantage of more attractive interest rates and the greater options when it comes to mortgage products.

Seller beware

While the buyer will have to go through the typical vetting process for the bulk of the mortgage, it would be wise for the seller to do their due diligence when it comes to vetting the buyer. When selling a home in a more traditional manner, the seller washes their hands of the property once the paperwork is signed; what happens to the buyer’s loan is none of your concern. But using the VTB option means that the seller is acting in a lender capacity and has a stake in the loan, and is therefore tied to the borrower. The seller will need to hire a lawyer to make sure that the agreement is iron-clad and that the consequences for defaulting on their loan are clearly outlined in the agreement. The loan is treated like a second mortgage, so if the borrower defaults on their primary loan, then the fate of the loan is at risk.

“Obviously you know that going through a realtor that [the borrower] has been FINTRACed and there’s different measures that everybody takes and if they’ve been approved on the first mortgage then it’s assumed that those things have taken place, so that would be part of the due diligence. But in addition to that, they might do their due diligence as well because they are going to be in second position behind the first mortgage, and so they want to know that if they didn’t make their payments to the vendor, trying to file for foreclosure in second position behind a first mortgage is expensive and timely,” says mortgage broker Pauline Tonkin. She recommends that “any time anybody is lending any money to anybody that they do their due diligence and whatever that requires is up to them.”

The return of the vendor take-back mortgage?

Times, they are a changin’. Although the housing market seems to be either pretty balanced in most of the country or favouring sellers (in the cases of Toronto and Vancouver), the opposite situations where a VTB would be ideal, escalating home prices are creating opportunities elsewhere for VTBs to creep back into the mortgage market.

“They’ve kind of gone out of fashion because no one’s talking about them but also, I strongly believe we have almost a whole generation of people that are either mortgage brokers, realtors, or borrowers and homeowners that have never seen high interest rates. They’ve never seen the challenges, and that’s when we use these solutions – it was difficult to get financing or the interest rates were higher and it was cheaper to get a vendor take-back,” says Drage. “So it’s almost like you’ve got a generation of people who’ve stopped talking about it.”

With the regulation changes not too far in our rear view mirror, Tonkin says we’re in a transitional period, and the outcome is uncertain when it comes to how buyers, and in turn the market, will react. And although she says VTBs probably not going to become popular anytime soon, they’re a viable option to help out buyers who are having trouble keeping up with escalating home prices.

“Getting down payment is one of the toughest factors for qualifying for a mortgage. People are having to go to different ways than ever before to get that sorted out. So I think any option that a seller or a real estate agent puts in front of a client to help with that down payment becomes a better option,” Tonkin says. “I don’t know if it will grow rapidly, but I think some people will be open to options like that just because they need the options. So if people are aware of it, for some it would create the opportunity.”

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