This process removes the need for banks and a mortgage. However, for the seller to enter into this agreement, they must own the home outright.
Before you decide to go the route of a vendor take-back mortgage, there are some things you should know. While these types of mortgages are great for some, they may not be the best situation for everyone. Here are some details regarding borrowing money this way.
What are the Pros and Cons of a Vendor Take Back Mortgage?
When it comes to vendor take-back mortgages, there are advantages and disadvantages. Depending on your financial situation, one of these may outweigh the other.
Pros
When it comes to VTB mortgages, those who are unable to get traditional mortgages have more access to financing. They also allow sellers to process a sale that might not otherwise go through. VTBs can also be combined with traditional mortgages to allow for larger purchases.
Another advantage of a VTB mortgage is that it can be advantageous to those selling in a buyer’s market. Buyer’s markets can be very difficult for sellers due to the abundance of buyers, but offering an alternative to a traditional mortgage can make it easier to sell their home.
Not only can VTB mortgages be used for those who sell residential properties, but they’re also good for those who sell commercial properties, investment properties or even a rental property. It allows the new owner to assume the property and the seller to defer capital gains while generating extra income. This means the seller has a few extra years before the property is technically sold and the capital gains tax can be spread through the years.
Cons
Along with the many positives for both buyers and sellers with VTB mortgages, there are also disadvantages. The main one is that interest rates are higher on VTB mortgages than on traditional mortgages.
This is because the seller is taking on significant risk when providing this type of mortgage, since there’s always a chance the buyer defaults. Depending on the type of deal, the buyer may have two separate loans to pay, meaning they must pay the primary mortgage lender and make regular payments to the sellers.
Unlike in a traditional sale, sellers don’t receive the full amount up front. This means the seller will receive the bulk of the funds over time, which can tie up their money. Since these types of mortgages are usually for those who have a hard time qualifying for a traditional mortgage, the risk of not receiving your money is greater.
How VTB Financing Works
With VTB financing, the seller is both the seller and the lender. This means that most of the buyer’s money will be received by the seller over time, rather than up front as in a traditional sale.
Because this type of sale isn’t regulated as it would be with traditional lenders, it’s also important that the contracts are clear and you have a lawyer negotiate for you.
There are a few different ways that vendor take-back financing can be done. The seller can mortgage the entire property or part of it. If they mortgage all of it, the sellers and buyers will negotiate a down payment and a payment schedule.
However, you can’t take over the seller’s mortgage; they can only offer a VTB if they no longer have one.
When it comes to the seller offering a partial vendor take-back mortgage, this can be done either to help the buyer afford the down payment to the bank or to secure full financing for the property. If the seller provides a partial VTB, then the buyer will have to make their mortgage payments as well as their VTB payments.
No matter the reason for the VTB, the seller will need to both provide and receive payment.
VTB Mortgage Rates
Unlike traditional mortgage rates, vendor take-back mortgages aren’t regulated. The rate for this type of mortgage is negotiated between the buyer and the seller. Once it’s been negotiated, it will be added to the sale agreement. However, with that in mind, the interest rates are usually higher than the market rate.
How Do VTB Mortgages Work in Different Provinces?
In Canada, there are very few regulations governing vendor take-back mortgages. This is because they’re more of an agreement between a buyer and a seller than they are a mortgage. For this reason, there aren’t many differences from province to province.
In provinces like BC, Alberta and Ontario, your lawyer will be able to tell you if there are any rules you need to follow.
How VTB Benefits the Buyer
While VTB is beneficial to both the buyer and the seller, the buyer will usually enter into a VTB agreement if they’re unable to qualify for traditional financing. With this type of mortgage, the seller sets the interest rate, but the buyer can purchase the home even if they don’t qualify for a conventional loan.
Depending on the agreement between the buyer and the seller, the buyer may be able to make a smaller down payment or take out a larger mortgage than the bank-determined financing limit. The payments that are to be made to the VTB are also negotiable.
Even though this can be the more expensive option when purchasing a home, it can also allow buyers who otherwise wouldn’t be able to afford one to do so.
How Does a VTB Mortgage Work in Ontario?
When it comes to mortgages in Ontario, vendor take-back mortgages are considered a legal form of seller financing; however, they’re also considered a form of creative financing. Instead of getting 100% of their financing from a bank, the seller will lend the buyer a portion of the purchase price.
The title of the home is still transferred to the buyer at closing. The seller then registers a mortgage on the title to secure the loan. All payments, including interest, are then made to the seller.
Are Vendor Take-Back Mortgages a Good Idea?
Whether a vendor take-back mortgage is a good idea depends on your situation. Since you don’t have to pass any strict tests, the sale price is more flexible. Those with a low credit score or who are self-employed tend to benefit most from this option.
It can also help bridge financing gaps and allow the closing to happen faster, since there is no red tape from a bank or credit union. However, there are some downsides to vendor take-back mortgages as well.
Even for buyers with a steady income stream, these are known to have higher interest payments and to be shorter-term than bank financing. This means that a balloon payment (a large payment at the end of the loan) might be required.
The Typical Interest Rate for a VTB Mortgage
Whether you’re purchasing investment property, residential property, or commercial property, the interest rate on a VTB mortgage is typically between 6% and 10%. This is usually between 2% to 4% above traditional banks.
Often, VTB mortgages are used as a second mortgage where the first mortgage is secured by traditional financing. This means that the VTB sits in second position and is secured against the property.
What Happens When a Buyer Defaults on a VTB Mortgage?
With any type of property sales in the real estate market, a real estate lawyer is used to protect both parties. They can help protect financial goals, allocating the sale proceeds and confirming the sale price.
When the seller agrees to finance the property, the lending conditions must be firmly laid out. If these terms are breached, the lender will issue a formal written notice specifying the default and giving the buyer a period to make up the payments and continue the arrangement until the end of the term.
If the buyer does not correct the missed payments, this alternative financing arrangement could result in foreclosure and revocation of ownership of the property. Without this legal oversight, the seller could lose out on interest income from the loan.
Can a VTB Sit in First or Second Position?
In Canada, vendor take-back mortgages are popular in a slower market. With residential real estate, qualifying for mortgage default insurance to get a low down payment isn’t always an option. Private lenders and VTB mortgages can help potential buyers enter the residential real estate market.
VTB loans can either be the primary mortgage in first position or act as a second mortgage. It can come in handy as a first mortgage when a bank mortgage just isn’t a possibility. While you don’t have the option of interest-only payments like you do with a new build, you can negotiate the repayment terms.
If you purchase a home where your financing options don’t quite cover the full purchase price, the seller lends the remaining balance. While this bridges the financing gap, it carries risk and will result in two loans.
Vendor Take-Back Second Mortgages
With a VTB as a second mortgage, it’s commonly just a second loan of between 10% to 20%. This portion of the loan has its own purchase agreement and is separate from your first mortgage balance. The buyer takes ownership as soon as both loans are in place and registered against the property title.
Capital Gains Reserve and VTB
When you sell a secondary property, rental or commercial buildings, for cash outright, then the entire amount is considered a taxable gain in the first year. If part of the sale was structured with a VTB mortgage, then you may qualify for a capital gains reserve.
The benefit means that you can spread the taxable capital gain over 5 years. Spreading out this gain can help you stay in a lower tax bracket and save you money on your tax bill.
How Land Transfer Taxes Apply With a VTB
Having a VTB mortgage doesn’t reduce or change the amount of land transfer and property taxes that you pay. This is because the amount you pay is based on the property’s fair market value, not just what was paid at closing.
What Should a VTB Agreement Include?
Just like any mortgage agreement, a VTB agreement should include the loan terms, payment structure, and the legal rights of both the buyer and the seller. Before the agreement is signed, you’re free to get independent legal advice.
The key takeaways of most agreements are what happens if the buyer stops paying the loan, how much the seller lends to the buyer, and other stipulations that most buyers like to include.
VTB Balloon Payments and Refinancing at Maturity
For VTB mortgages, balloon payments must be paid when the loan matures. This means the loan must be paid in full. This amount can be paid with a new loan, by selling the property, or by using the cash savings. If you cannot make this payment, it will be considered a default on the loan.
Example of a Vendor Take-Back Mortgage
Here’s an example of using a VTB as a second mortgage.
Let’s say you purchase a home for $750,000. Your down payment is $100,000, and your mortgage is $550,000, leaving you with $100,000 owed. If you get a VTB loan based on this amount, then you’ll have a VTB of $100,000.
In addition to your mortgage payments, you’ll make the required payments on the VTB amount until it’s paid in full.
VTB Sellers: Power of Sale Vs. Foreclosure
Just like with a traditional mortgage, you can end up going through the power of sale or foreclosure if you don’t make your payments.
Power of Sale: With this process, the lender forces the sale of the property on the market without first taking formal legal title to it. This is generally the preferred process because it is faster and less expensive. If the home sells for more than you owe, the owner will get to keep the surplus. When the VTB is the second mortgage, then the first mortgage must be paid out first.
Foreclosure: With this process, the lender will take ownership of the property through a formal court process. Since this is slower and more complex, it isn’t the preferred process. In this process, however, if the home sells for more than what was owed, the lender will keep the profits.
