Vendor Finance: The Pros and Cons

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Vendor finance can help sellers sell quickly and for the right price, while offering buyers an alternate way into home ownership. It is much riskier than traditional options, so it pays to be well informed before entering into a vendor finance agreement.    

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.

The buyer pays a premium interest rate which creates profit for the seller. 

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.

The property title is not registered in the buyer’s name until the set price has been fully repaid or the mortgage is refinanced into the buyer’s name.

Why sell with vendor finance?

Why offer vendor finance
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.

Seller ProsBuyer Pros
Gives the option to sell when there are few suitable offersCan secure their dream home years before they will qualify for a bank loan
Allows the seller to sell for their asking price or moreDon’t need home loan approval to buy
Can help a seller sell their property quicker A vendor-financed deposit allows buyers to qualify for a home loan

The cons of vendor finance

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

One of the biggest cons is that vendor finance doesn’t adhere to the same rules as other credit arrangements and is not covered by typical consumer protections. 

Seller ConsBuyer Cons
Ownership is often confusing, making it unclear who should maintain the property and pay utilities.Banks may not agree to the refinance if the property depreciates significantly.
Sellers can be left out of pocket, especially when they are unclear on their rights.Buyers normally pay higher than market value, which can make it hard to build up equity to later refinance.
If a buyer defaults, the seller is at risk of having their home repossessed by the bank.Sellers decide on penalties for late and missed payments, leaving the buyer at risk of harsh penalties.
The situation can become complicated and stressful if a buyer is living in the home and defaults on payments.In cases where the seller remains the owner, the buyer’s investment is at risk if the seller goes bankrupt and other parties make claims on the property.
Sellers have less upfront cash to use as a deposit on their next home.Premium payments and complicated agreements can mean the buyer never ends up owning the property.
Buyers can lose their entire investment if they default on the repayments and the seller’s bank repossesses the home.

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.

Even with these measures, many vendor finance arrangements fail, sometimes leading to significant loss for vendors.

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.

Buyer Beware

Although vendor finance is an option to get you into home ownership, it carries significant risk. Many buyers have been financially ruined when vendor finance agreements have failed.

What is included in a vendor finance contract?

Vendor finance agreement
Vendor finance agreement

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.

Sellers often favour buyers who are able to refinance quickly, which can lead to much better terms.

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:

The legal status of these schemes is extremely complex and it is often unclear which laws apply. Vulnerable buyers, and some vendors, can suffer significant detriment yet have limited avenues for redress.

What other options exist?

Discuss options with an agent
Discuss options with an agent

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:

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.