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Vendor finance
Vendor finance may help you buy a property without having to apply for a bank loan, but there are some major risks involved: You could even lose your home.
Vendor finance, or seller finance, is a rare form of property transaction. In a vendor finance arrangement, the buyer borrows the money from the seller. It's essentially a private financial arrangement with a contract, except the lender and the seller are the same party.
While vendor finance may seem like a potential solution for borrowers who have trouble saving a deposit or fall outside lenders' criteria, the risks involved can far outweigh the potential benefits. Before entering into any agreement, it's crucial you seek the advice of a solicitor and make sure your interests are protected. However, considering the risks, vendor finance may be too fraught with potential pitfalls to be worthwhile.
How does vendor finance work?
Vendor finance agreements vary a lot depending on the specifics of the contract you enter into. But in every example, the purchaser and vendor (seller) arrange the finance terms privately rather than through a lender.
The buyer normally pays a small deposit to the seller and makes repayments to the seller over time. These repayments may or may not include interest, and the purchase price (and therefore the repayments) are typically higher compared to a standard loan.
For instance, a standard home loan may come with an interest rate of 2.5%, but the vendor finance provider charges 4%. Or the property would normally sell for $500,000, but you agree to pay an inflated price of $550,000.
Depending on the individual agreement, you will either have the option of paying the instalments until it is paid off in full or you will make the repayments until you’re in a position to qualify for a normal mortgage, in which case you’ll refinance the loan and pay off the balance in a lump-sum payment.
Because of the need to refinance, borrowers need to ensure that they can meet the repayments, save enough for a deposit and maintain a good credit rating to qualify for a home loan during this time period.
Should everything work according to plan, once you’ve made the last repayment, you assume ownership of the property. However, such agreements often end with buyers losing the funds they've put towards their home.
Buyer beware! Why vendor finance is risky
Vendor finance carries some significant risks, many of which may far outweigh its benefits. A study by the Consumer Action Law Centre found vendor finance schemes were often detrimental to would-be buyers, and commonly ended in buyers being unable to complete their purchase.
Before entering into any agreement, you should consult a solicitor.
Risks of vendor finance include:
Expense. Vendor finance transactions often mean a higher purchase price than market value. That's one of the upsides for the seller. Also, interest rates are usually much higher, which can make the loan more expensive.
Ownership. As your name won’t be included on the property title, your interest in the property is at risk. For instance, if the vendor goes bankrupt, others can make claims against the property. This is why you should ensure that there is a clause in the contract that explicitly states that the title will be transferred to your name when the final payment is made so that you assume ownership of the property.
Harsh penalties. As laws regulating vendor finance are extremely murky, the buyer is often at the mercy of the seller. This means sellers can impose harsh penalties for missed payments, which can include the buyer forfeiting everything they've paid towards the property.
What kind of buyer does vendor finance work for?
Most borrowers should not even consider vendor finance. It's only really an option if:
You lack genuine savings. If you're unable to complete a large deposit, such as 20% of the purchase price, which is a requirement of many lenders for a home loan, then vendor finance may provide you with the time and flexibility to get your finances in order before refinancing with a bank.
You have a bad credit score. If you have a poor credit rating or a lack of sufficient credit history, it may be hard to qualify for loan with a lender. Vendor finance may be a suitable option in this case.
You're self-employed and can't provide income documents. If you run your own business but you have poor cash flow and are unable to demonstrate financial discipline or savings, vendor finance may be a solution.
What are the different types of vendor finance available?
There are 3 common forms of private vendor finance:
Terms finance. This structure occurs where the purchase price is repaid by instalments and the title remains with the vendor until the final instalment is paid or the loan is refinanced with a bank. The duration of the contract may be 25-30 years, but a purchaser normally pays it out as soon as they can refinance, which normally occurs within 2-5 years.
Mortgage-backed finance. A mortgage-backed finance structure is when the vendor loan is used as deposit finance, where the deposit is funded by the vendor with an external party and title transfers to the buyer right away. The vendor therefore funds the difference between the price and the external finance and takes security for payment through a second mortgage over the property.
Lease option finance. In this scenario, the property is leased to the purchaser while payments are made under an option towards the deposit on the purchase of the property.
Does the buyer have to put down a deposit?
It depends on the vendor and the agreement you enter into. It may be possible to purchase the property with no deposit. But you will generally be required to hand over a deposit of around 2-5% of the property purchase price. This compares favourably to a 10-20% deposit required by most Australian lenders for a standard mortgage product.
What are the costs involved?
The same fees and taxes are payable with vendor finance as they would be with a standard home loan. However, the additional complexity means more legal work and higher costs than would normally be associated with a traditional mortgage product.
Legal fees. Legal charges for vendor finance could set you back around $1,000-$2,000. This fee is charged to have a legal professional look over the agreement and ensure that all the paperwork is in order for you to take ownership of the property.
Taxes. The amount of stamp duty payable will vary depending on which state you live in and the value of the property.
Repayments. You'll need to ensure that you have sufficient funds to meet the monthly repayments. If in doubt, consult the services of an accountant or financial adviser to ensure that you're in a strong financial position to service the repayments.
We update our data regularly, but information can change between updates. Confirm details with the provider you're interested in before making a decision.
We update our data regularly, but information can change between updates. Confirm details with the provider you're interested in before making a decision.
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Frequently asked questions about vendor finance
Yes. State and federal legislation provide legal frameworks that govern vendor finance in Australia.
Purchasing a property where the seller provides finance is legal when conducted correctly. As a rule of thumb, private owners can normally sell their properties through vendor finance legally, but businesses must either carry a real estate licence or a credit licence, depending on the type of transaction being undertaken.
However, some argue that current legislation is not adequate to deal with the loopholes and risks associated with vendor finance.
If you’re thinking of purchasing or selling property through vendor finance, you should seek a solicitor to run you through the process and legal considerations.
There are many homeowners and investors who may not immediately need the money that is tied up in their property and therefore don’t mind if it is paid off over time.
Like any transaction, the seller will want something in return for their flexibility. It is therefore likely that you will pay a slightly higher price for the property, around 3-7% of the value on the sale date. This is the premium you will pay in return for alternative and flexible short-term finance.
Although you won’t be the legal owner, you have the option of having your name registered on the title. Your solicitor can lodge a legal document that will prevent the vendor from selling the property without your approval.
If you don’t make your repayments on time, it’s likely that the vendor will also fail to meet their own repayments on their mortgage given that your repayments will most likely form their repayment amount. If this happens, the vendor’s lender may charge late fees or other penalties and the vendor may pass this cost on to you.
If you’re experiencing financial hardship and you don’t think you’ll be able to make your repayments, then you should get in touch with the vendor as soon as possible to negotiate a new arrangement or set up a different repayment schedule.
No. You should be able to refinance with a bank at any time. As soon as you have built up enough equity and a good repayment history, you should refinance and pay out the vendor. You should refinance as soon as possible, as it’s likely that you’ll pay less interest to a lender than you would to the vendor.
As the buyer, you are responsible for looking after repairs and maintenance to the property.
You need to reimburse the vendor for council rates, water rates, insurance and taxes related to the upkeep of the property.
Generally, you can conduct cosmetic renovations to the property, such as painting or installing a new kitchen, without seeking the vendor’s permission. However, if you want to make major structural changes to the property, you will normally need to speak to the vendor (and the local council) first.
Richard Whitten is a money editor at Finder, and has been covering home loans, property and personal finance for 6+ years. He has written for Yahoo Finance, Money Magazine and Homely; and has appeared on various radio shows nationwide. He holds a Certificate IV in mortgage broking and finance (RG 206), a Tier 1 Generic Knowledge certification and a Tier 2 General Advice Deposit Products (RG 146) certification.
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