Benefits For The Vendor:
Offering a property for sale under a terms contract can have many benefits to a vendor, particularly for vendors where the property is an investment. It is a great way for an investor to receive more income from the property then would normally be achieved if the property was rented out. This additional income will certainly mean this investment is making money each year which can be used as a supplementary income for the vendor or used to boost the overall cash flow of the vendor’s property investment portfolio.
This additional cash flow is a very powerful element for investors wanting to expand their property portfolio. When applying for finance to purchase a property you need to demonstrate to the lender that you have enough income to service the debt you are requesting. By having a property/s where you have significant surplus income over and above all costs means you have additional income that you can evidence to demonstrate your capacity to take on more debt. In most instances, by having a terms contract in place will increase your borrowing capacity, so the more of these you have in your portfolio, potentially the more property you can buy.
You will also have an occupant of the property that is planning on staying there for an extended period of time, providing the vendor with more revenue certainty. The occupant will also be more likely to take care of the property and it is also very common for the purchaser to make improvements to the property, after all, they are purchasing it.
In some instances under a terms contract, the purchaser will not complete the contract and may request to be released from the contract. This can have huge benefits for the vendor because during the time the agreement was in place the vendor was collecting substantial income and now that the purchaser has been released from the contract, the vendor is now again the only person with an interest in the property and therefore entitled to all future capital growth in the property from the date of the release letter being signed. The vendor will be obligated though to pay the outgoing purchaser any equity they have built up in the property during the time the terms contract was in place.
Having just outlined the benefits to the vendor, assuming the purchaser does not request a release from the contract and does go on to complete the purchase, the vendor has traded the additional income for not receiving any capital growth in the property over and above the agreed sale price. It certainly doesn’t detract from the benefits that can be gained from the terms contract, but it does highlight that this arrangement is an income generating strategy and a far less capital appreciation strategy.
Benefits for the purchaser:
As with the vendor, the purchaser has many benefits purchasing a property under a terms contract. It’s great for purchasers who have a small deposit which wouldn’t meet the minimum amount required if applying for a loan through a conventional mortgage provider. This enables purchaser’s in this position to enter the property market sooner than they otherwise could have.
Vendors will also consider purchaser’s that may have a less than perfect credit history, which again, can be a barrier to obtaining finance the conventional way. This by no means suggests that vendors will provide this opportunity to everyone, but a personalised solution can be assessed based on the credit history of the purchaser.
Purchasers that have varied income streams can also be considered as suitable purchasers under terms contracts. This can include people starting a new job, changing industries, starting a business, reliant on commission or bonuses or self-employed people who don’t have their financial records up to date. Purchasers in these categories can often be overlooked in the conventional financing arena as unsuitable borrowers. Diligent assessment will need to be undertaken for people in these categories but solutions can often be found to assist purchasers that find themselves in this position.
The purchaser really does have control over the property which provides comfort and certainty. Changes and improvements to the property can often be undertaken which can help increase the rate at which equity is building in the property. The purchaser can also sell the property on the open market or negotiate with the vendor to pay them out their equity should there circumstances change and they need to move on.
Interest rates and fees that may apply to terms contracts are often in line, if not more competitive than a non-conforming lender which provides finance solutions to purchasers that fall into some of the categories I mentioned earlier. Terms contracts really are a genuine alternative for purchasers seeking a solution to enter the property market.
Although vendor finance really is a win win for both parties, like all investments/opportunities, there are risks that need to be understood and considered before either party enters into an agreement. The vendor needs to ensure they are compliant with their obligations under the agreement and complete their due diligence on the purchaser to ensure they are credit worthy applicants that can fulfil their obligations under the agreement as well. The vendor can face significant disruption to the performance of the terms contract if the purchaser fails to meet their obligation and it can take time and financial resources to bring the purchaser back in line or move them on.
From the purchasers position, they need to be dealing with a credible vendor that agrees to fair and reasonable terms in the agreement, particularly with the sale price and interest rate and fees, to ensure there is real opportunity for the purchaser to complete the contract at some point in the future. The vendor also needs to meet its obligation under the agreement, in particular meeting its financial commitments to the property outgoings and any mortgage that may be on the property.
Seeking the right professional advice is critical for both parties to ensure the agreement is compliant in every way and meets the needs of both the vendor and purchaser. Risk shouldn’t be a barrier to either party entering into a terms contract agreement, they just need to be understood, and appropriate action taken to mitigate and minimise them.
To read the part 1 of this article, click on Vendor Finance – Part 1