How does a vendor take-back mortgage work?

Traditional mortgages may not be for everyone, as some may need a helping hand from an unlikely ally—the property vendors themselves. Buyers looking to purchase a property but without enough cash to finance the transaction could take advantage of a vendor take-back mortgage but be warned: it’s a complex option that poses a few risks.

Defining VTB
A Vendor take-back mortgage, or simply VTB, is when the seller or vendor basically becomes the lender. He or she lends the buyer money to purchase the home which the vendor is selling. VTB only works if the seller owns the property outright—a vendor who is still paying the mortgage of the property they are selling cannot offer VTB.

Overtime, the buyer will repay the seller in line with their agreed repayment amount and interest rate, which could be generally higher than the buyer’s mortgage rate but may be lower than borrowing from a private lender. The amount the buyer can borrow varies: it could be just enough to cover closing fees, part of their down payment, or even a large portion of the home loan.

For example, you’d like to purchase a $500,000 home, but only have $50,000 to cover down payment and closing costs. Vendor take-back works when your vendor agrees to front a certain amount that could help you come up with enough money for the down payment and closing costs.

Keep in mind that using VTB to cover a portion of your down payment could be tricky, as your mortgage lender would still want to see that you have enough money upfront to know that you’re shouldering some of the risks.

The amount lenders would like to see when using VTB may differ, but based on strict guidelines, lenders may like to see up to 10% of a buyer’s own money, mortgage broker Pauline Tonkin says about getting VTB financing.

When does vendor financing make sense?
VTB only works for specific situations; it may not be the solution to everyone’s mortgage woes. For example, VTB may work in a buyer’s market. If there are plenty of homes and realtors are finding it hard to shift their inventory, vendor financing may work.

Instead of waiting for a buyer with enough cash for a down payment, the seller could help the prospective buyer with their down payment and get the vendor’s property off the market.

Another situation where VTB could work is when the buyer has poor credit. The seller may opt to just help this buyer instead of waiting for another one to come.

VTB is also primarily used by investors. They could use this tool if they’re looking for a short-term fix. Say, you’re trying to build up your credit or would like enough money for renovation, vendor financing could work for a brief period. It could buy you some time, and when you’re in a better position you could get a good deal and take advantage of more attractive loan products in the market.

Is VTB a good idea?
Vendor financing works for specific scenarios, but it’s an attractive option for both buyers and sellers. VTB poses some advantages that may entice you to try it out.

For a vendor, some of the advantages of this tactic are:

  • Steady income. Since you’re financing a portion of your buyer’s loan, monthly repayments could increase your cash flow and will give you spendable income.
  • Shorter time in the market. VTB may attract buyers who would like to purchase a property but do not have adequate funding. Vendor financing may entice buyers to purchase your home, resulting in the home being on the market for a shorter time.
  • Better pricing. As a seller you may be in the driver’s seat, commanding a better price for your property. Since the buyer may have trouble getting a traditional mortgage, he or she may agree to your purchase price.

For buyers, some pros VTB may offer are:

  • Flexible costs. As a buyer, you may shell out whatever amount you want for a VTB since you’re getting funding from your seller. You may not have to comply with lender-specific or government-required minimums. However, you still need to negotiate the amount with your vendor-lender.
  • Faster closing. With vendor financing, you won’t have to wait for your traditional lender to process your application. Preparations for closing day may also be unnecessary as you’re dealing directly with the seller. Of course, there are still legal requirements you may have to comply with.
  • A good alternative to traditional home loans. If you cannot qualify for a mortgage due to various reasons, a vendor take-back mortgage may be an option for you.

These advantages for both sellers and buyers could be enticing, but you have to weigh the good and the bad before making a decision. For sellers, VTB could massively backfire—the buyer could stop repaying their loan anytime, which may lead to a forced property foreclosure. You may also have to shoulder repair costs, should you need to take back the property. Additionally, you have to pay your mortgage in full before you get to offer vendor financing.

Paying for a higher interest is one of the risks buyers should consider before getting a VTB. Since it’s not a traditional home loan, the vendor-lender has the upper hand when deciding the interest rate. You may also have to pay the mortgage in lump sum if the seller decides to liquidate their estate.

Exploring your mortgage options
While vendor financing sounds like a dream come true, you still need to be cautious about entering such an agreement. Many home loan products in the market could better fit your need.  A professional such as a mortgage broker could help you explore your options and give you a better understanding of the products that fit your finances.

A broker has various lenders and loan products in their panel, enabling them to recommend what may work for your unique situation. He or she could also help you pick out loan features that can help you pay off your mortgage a bit faster.

Want to explore your options with a professional? Find a local broker that could assist you.

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