How Does Vendor Finance Work?
Thinking of purchasing a property but suffering from poor credit? Read below to find more about an alternative to taking out a mortgage.
What is Vendor Finance?
Vendor finance is a type of finance where the vendor itself funds part of the purchase proceedings. Also called Seller Finance or Owner Finance, it allows the purchaser to own a home without a traditional mortgage.
This is particularly beneficial to you as a purchaser, as it allows you to own a home with a flexible payment schedule, despite a bad credit history. In a typical vendor finance agreement, you would arrange the finance terms privately with the seller and pay off the purchase price in instalments to them. The duration of the term might be set for a long period, such as 30 years. But they are usually aimed at allowing you to pay off the amount as soon as possible once you can refinance the debt through conventional home loans.
Types of Vendor Finance
There are three different types of Vendor Finance:
- Terms Finance: This happens when the purchaser repays the purchase price in instalments and the title to the property remains with the vendor until they repay the entire amount or refinance the loan.
- Mortgage-back finance: The funds from the vendor act as a loan deposit, and the title to the property transfers to the purchaser right away. The vendor thus funds the difference between the price and the external finance.
- Lease option finance: The purchaser leases the property and the payments act as an option towards the deposit on the property’s purchase price.
While the fees and tax payable are the same with vendor finance as with a traditional bank loan, the increased complexity involves additional legal work. Consult a conveyancing lawyer to ensure your interests are protected.
- Insufficient savings: A vendor finance is useful if you don’t have sufficient savings for a mortgage deposit. It provides a purchaser with extra time and flexibility to sort out their finance and create a deposit.
- Credit history: A poor credit rating can make it difficult to qualify for a mortgage. Vendor finance can provide a suitable alternative.
- Self-employed: Obtaining a mortgage can be difficult for business owners lacking a steady cash flow. Vendor financing requirements aren’t as strict and offer flexible repayment terms.
- Ownership: There is high risk involved in purchasing the property with vendor financing. As typically the property title does not register in your name until you’ve repaid the instalments, your interest in the property is unprotected. If a vendor goes bankrupt, their property might be claimed by others with a secured interest. Therefore it is a good idea to include a clause registering your interest in the property in your loan agreement.
- Expensive property: The vendor faces a higher risk when accepting the agreement. Therefore they require compensation in the form of a higher return. The purchase price and repayments are therefore likelier to be higher than usual.
- Penalties: Vendor financing isn’t as regulated as the banking sector. The vendor holds higher power and may impose harsh penalties for missed instalment payments. This could include forfeiting any rights in the property itself.
Vendor financing seems like an ideal solution to borrowers unable to secure a mortgage for their property. However, it involves severe risks that can outweigh any benefits. Make sure you consult a lawyer before accepting any vendor financing agreements.
Avi is a legal intern at Lawpath. He is currently studying a Bachelor of Commerce (Finance) with a Bachelor of Laws at Macquarie University.