Vendor finance is a form of private finance where the owner of a property (The Vendor) agrees to sell the property under the provisions of a terms contract. The terms contract will outline all of the particulars of the sale agreement including the purchase price and the period of time the payments will be made, as well as the payment amounts, to complete the purchase of the property. In laymen’s terms – the owner of the property finances the purchaser.
These agreements are typically drawn up over a 30 year term although the intention would be in most instances for the contract to be paid out much sooner than that when the purchaser is in a position to refinance the debt by way of a conventional home/investment loan. This type of financing arrangement would appeal to a purchaser, who for whatever reason, can’t qualify for a conventional loan at the time of purchase.
Structuring the agreement:
The vendor and the purchaser agree on a sale price for the property. The purchaser should, and in most cases will, put down a deposit for the purchase which will then be deducted from the sale price of the property. So let’s say the sale price of the property is $250,000 and the purchaser puts down a deposit of $25,000, the remaining balance owed under the terms contract will be $225,000. It is on this remaining balance figure that the repayments under the terms contract will be calculated.
An interest rate will be agreed upon between the two parties, say 7%, and the repayments can be determined. On a 30 year loan agreement, $225,000 at 7% means a weekly payment of $374.23. The purchaser is also responsible for paying the out goings on the property like council and water rates and insurance. These additional costs are then calculated and added to the weekly payment. For example they may total $40 per week making the payment to the vendor $414.23.
The interest rate under the terms contract is most likely to change over the term of the agreement just like it would under a conventional property loan arrangement. If it is a variable rate, which most are under these agreements, it will be most likely be linked to any changes by the reserve bank, or if the vendor has a mortgage over the property, be linked to any changes in that interest rate. Fixed rates can be agreed to under a terms contract, but like conventional fixed rate property loans, can be subject to break costs if the loan is paid out or greatly reduced during the fixed rate term.
While under a terms contract agreement the title of the property remains in the vendors’ name. This will also mean that the council and water rates, as well as insurance will also be in the vendors name, paid by the vendor and be recouped each week via the weekly payment under the terms contract agreement. Title to the property transfers to the purchaser when final payment is made and stamp duty is paid to complete the property transfer.
The purchaser will also be responsible for any other costs that arise in relation to the property like maintenance and repairs. This is because rights to the ownership of the property belong to the purchaser from the date and signing of the terms contract, meaning the purchaser is entitled to all future capital growth in the property and is therefore responsible for all costs associated with the property just like any property owner.
As the vendor is providing finance, the vendor will need to comply with any legislative requirements for a finance provider. These will include but not limited to:
- Ensuring the finance is not unsuitable to the purchaser
- Making sure the council and water rates as well as insurance are paid and up to date
- Confirming and verifying the borrowers can meet their financial obligation under the terms contract agreement
- The vendor will need to provide regular loan statements to the purchaser
- Meeting its financial obligations if there is a mortgage on the property
- Ensuring there are no changes to any mortgage over the property after the terms contract agreement has been signed, including but not limited to increasing the debt or refinancing
- Ensuring the property is not cross-collateralised with any other properties
- Having a dispute resolution mechanism in place
- Ensure proper process is followed and take appropriate action if the purchaser falls into arrears or develops poor conduct on the loan facility
I would just like to elaborate a little further on the point about ensuring the finance is not unsuitable to the purchaser. It is critical that the vendor takes appropriate steps to understand the purchaser’s objectives and assess whether entering into a terms contract will in fact address and meet those objectives. By entering into the agreement is the purchaser likely to be able to complete the agreement at some point in the future, is their income sufficient to meet their loan repayment commitments and are there any foreseeable changes that may affect their capacity to meet their obligations under the agreement. If all reasonable steps have been taken to satisfy this point, then a vendor terms contract can be considered as a viable option for the purchaser to buy a home.
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Back in 2000, Garry Harvey was a 26-year-old Victorian looking to buy his first home. Now, still shy of his 40th birthday, YIP’s runner-up for Investor of the Year 2012 has amassed a diverse portfolio of 39 properties that return more than $500,000 a year in rental income and have given him $2.75million in equity to work with. Garry is a fan of buying in bulk, and he has made the most of a strategy centred on subdividing blocks of units.
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