Vendor Finance: The Pros and Cons

What is vendor finance?

Vendor finance allows buyers to purchase a property when they do not qualify for a traditional home loan. The seller organises the finance for them and effectively loans the buyer the money to buy their home.

The three types of vendor finance are:

1. Terms finance or wrap-around loan
2. Vendor-financed deposit
3. Lease option finance or rent-to-buy

Terms finance/wrap-around loan

This type of vendor finance arrangement involves a loan contract between the seller and the buyer. Essentially, the seller must still meet their home loan obligations with the bank but the buyer is the person paying the mortgage installments.

Typically, the property title remains with the seller until the buyer pays the final installment or refinances the property. The contract duration is usually 25 to 30 years but most buyers refinance within 2 to 5 years.

Vendor-financed deposit

In this arrangement, the seller loans the buyer the deposit (20%) and the buyer gets a traditional home loan from a bank for the remainder of the property price (80%).

The buyer will have two home loans: one through the bank and one through the vendor. Their aim is to refinance the vendor loan within 2 to 5 years.

Lease option finance/rent-to-buy

With this finance arrangement, the buyer rents the property from the seller at higher than market rent. In return, the buyer has the option to pay a set price for the property at a later date.

Why sell with vendor finance?

Sellers can benefit in two ways by offering a vendor finance option to buyers:

1. Properties sell faster because they appeal to more buyers.
   Offering a way to pay that appeals to low income earners or sole traders expands your pool of buyers. This makes it more likely that you will find a buyer sooner.
2. The seller can sell for a higher price.
   Rather than discounting to encourage offers, you can offer payment terms that suit the needs of the buyer.

It’s especially beneficial to sellers in a buyers market that is flooded with similar properties because it provides opportunity to buyers that are excluded from traditional cash sales, differentiating your property from others.

How to qualify for vendor finance

Vendor finance is aimed at low income earners, self-employed workers and those with a bad credit history. However, you must still satisfy the following criteria to qualify:

1. You need a minimum of 2% of the purchase price for the deposit
2. On your current income, you must be able to afford the amount borrowed
3. The property should be in a major city or regional area.

Buyers should be in a good position to take on a loan and should have a good reason for any bad credit history. Sellers should still do due diligence to find a quality buyer.

The pros of vendor finance

Vendor finance has pros for both the seller and the buyer.

The cons of vendor finance

Although vendor finance is an option for some buyers and sellers, it does carry significant risk.

How sellers can minimise risk

Sellers can make vendor finance safer by:

• Using a qualified solicitor to draft the loan agreement
• Avoiding sample vendor finance loan agreements
• Conducting due diligence on potential buyers
• Ensure the buyer gets independent legal advice
• Educating themselves on vendor finance rules.

How buyers can minimise risk

Buyers can reduce the risk involved in these types of private agreements by:

• ensuring they understand the terms of the agreement
• seeking independent legal advice
• carefully calculating the future costs of their finance agreement, as missed payments can lead to the loss of their deposit and the option to buy the property
• ensuring they can afford the repayments while saving for a deposit and maintaining a good credit rating, so they can refinance in 2 to 5 years time.

What is included in a vendor finance contract?

Every vendor finance agreement is different, as they are privately negotiated. Here are some terms that are typically included:

• Loan amount
• Loan term
• Frequency of repayments
• Instalment amounts
• Date the first instalment is payable
• Lump sum repayments (if any), how much and when?
• Interest free period (if any)
• Interest rate on loan amount

What costs are involved?

Vendor finance incurs the same costs that traditional home loans do, with some added extras:

1. Repayments are usually higher than traditional home loan repayments
2. Legal costs are higher for both the seller and the buyer
3. Stamp duty will depend on the value of the property and the location.

Is vendor finance legal?

Yes, it is currently legal in most of Australia, but this may change in the future.

Victoria

In 2019, the Parliament passed a bill officially banning vendor finance schemes, including rent-to-buy, from the Victorian housing market.

South Australia

Vendor finance is illegal in South Australia.

Rest of Australia

All other states allow vendor finance agreements. However, due to their risky nature, more states may follow suit and ban these schemes.

In their report, the Consumer Action Law Centre states:

What other options exist?

Due to the level of risk associated with vendor finance, it is a good idea for sellers and buyers to exhaust all other options before entering into a vendor finance arrangement.

Other options for sellers

When faced with few offers on your property, it can be tempting to sell using vendor finance. However, there are other options that carry far less risk. You could:

• Discuss options for finding more buyers with your agent
• Take your property off the market and relist later
  In the meantime, you could renovate or spruce up the property and wait for a sellers market.
• Stage your home and take new photos and videos
• Change your agent and/or marketing strategy

These options may cost you time and money but are far less risky than offering vendor finance. Plus, you get cash in your pocket up front when the buyer organises their own finance.

Other options for buyers

Many potential buyers lack a deposit when they start looking for a home. This doesn’t mean you can’t get a home loan, and resorting to vendor finance may hurt in the long run. Here are some options that might work for you if you have lower savings or no deposit:

• Guarantor loan
  A family member provides a guarantee, which is secured on their own home loan.
• Equity loan
  You can refinance your existing loan to use equity as a deposit.
• First Home Loan Deposit Scheme
  You may qualify for a home loan with only a 5% deposit. The government acts as the mortgage insurer, which saves you money on lenders mortgage insurance.
• Gift as a deposit
  Some lenders will accept a deposit that was given as a gift instead of saved up by the purchaser.
• Personal loan as a deposit
  High income earners with a good credit history may be able to get a personal loan to cover the deposit. However, you must still have 5% of the deposit saved.

Is vendor finance the right choice?

If you’re considering vendor finance or want to discuss other options for selling or buying a home, speaking to an agent is a great place to start. An experienced agent can help you find an option that’s right for you. Compare your local agents today.