Many prospective homebuyers wanting to get in on the scorching Canadian real estate market share one issue: they need a significant down payment to obtain an advantageous mortgage loan. It’s either that or keep signing lease contracts. With average property prices across the country rising to their highest level on record (the homes for sale in Vancouver and Toronto are valued at more than $1M), down payments frequently surpass the six-figure range and saving for one might take too long.
The Vendor Take-Back Mortgage (VTB) may come as a solution. This often underused financing option can be helpful for buyers who may not have enough money saved up to make a down payment or for sellers looking to encourage a purchase without lowering their asking price. This blog post will explain what a Vendor Take-Back Mortgage is and how it works. We’ll also discuss the pros and cons of this type of mortgage so that you can decide if it’s right for you!
What Is A Vendor Take-Back Mortgage?
A Vendor Take-Back Mortgage (VTB), also known as Seller Take-Back Mortgage, Seller Financing, or Owner Financing, is a type of mortgage in which the property’s buyer gets a loan from the seller to guarantee the transaction. In that scenario, the seller also becomes the lender. There are two types of Vendor Take-Back Mortgages:
Partially-Funded VTB Mortgage – The seller lends the homebuyer a part of the amount needed to purchase the property. That money usually goes towards the down payment so that the buyer can get a more beneficial mortgage loan from a bank. This is the most common type of VTB mortgage.
Fully-Funded VTB Mortgage – In this type of VTB, the seller finances the buyer with the total amount needed to purchase the home. There are no other lenders involved in the transaction.
How Does The Vendor Take-Back Mortgage Work?
The Vendor Take-Back Mortgage allows the buyer to obtain more cash and the seller to get a quicker, easier sale. By becoming a lender, the seller charges a higher interest rate than a bank, yet less than a private lender. Let’s explain it all better with an example:
If a buyer wishes to purchase a $1,000,000 home for sale in Toronto, they’ll need a 20% down payment on a fixed-rate mortgage provided by a bank, which would be $200,000. If the buyer only has $100,000 in their bank account, another $100,000 may be available through a VTB. The bank would then lend the buyer 80% of the purchase price to acquire the home. Now, the property has two mortgages:
- A fixed-rate mortgage of $800,000 owed to the bank.
- A Vendor Take-Back Mortgage of $100,000 owed to the seller.
Traditional Mortgage vs. Vendor Take-Back Mortgage
A mortgage is a type of loan secured by the collateral of a real estate property. A conventional mortgage is regularly extended by a bank and has a fixed interest rate for the loan duration. In Canada the standard is a five-year mortgage amortized over 25 years. The following factors might influence interest rates on loans from a bank or financial institution:
- Term of the loan
- The loan amount
- The borrower’s credit quality
In the end, traditional mortgages are a lower-risk deal for lenders since the additional equity in the property serves as a safeguard against potential losses in the case of loan default.
On the other hand, when a buyer takes out a Vendor Take-Back Mortgage, habitually, they’re already relying on a primary source of financing, which is most likely a bank. This makes the VTB a second lien on the property, a subordinate claim on the asset. This type of mortgage tends to be more flexible regarding the size of the loan, its duration, and the borrower’s qualifications. Since all of that involves higher risks for the lender (the property’s seller), the VTB frequently has higher interest rates than a traditional mortgage.
The Vendor Take-Back Mortgage For Sellers
Even though VTBs are incredibly beneficial to sellers under some circumstances and relatively secure, you should take some precautions before venturing to lend money within the transaction. Financing the buyer has its pros and cons, and here is a list of some of them:
VTB Pros For Sellers
- The VTB is more flexible. You can negotiate with the homebuyer the terms and conditions of the loan.
- VTB helps you sell the property faster.
- You can profit from the VTB loan’s high-interest rates.
- You may lower the tax burden on capital gains.
- You keep the home’s equity and hold a percentage of the loan equal to the amount owed until the Vendor Take-Back mortgage is paid off in full.
VTB Cons For Sellers
- You need to own the property outright and have no mortgage dues of any kind.
- You don’t get all the cash upfront.
- The buyer might have credit history problems, and they could default on the loan.
- In case of a default, your loan will be considered a second mortgage and paid back only after the primary loan (bank, private lender) is repaid in full.
- Since you’re the seller and the lender, you’ll need a second contract to negotiate the terms of the agreement which means additional legal fees.
The Vendor Take-Back Mortgage For Buyers
Buyers looking to enter the real estate market with a Vendor Take-Back Mortgage should consider that this is a complex option that poses some risks. Here are some of the pros and cons of the Vendor Take-Back Mortgage for homebuyers:
VTB Pros For Buyers
- A VTB means fast and relatively easy access to capital to increase your down payment or to purchase that single-family home or lakefront condos altogether.
- You’ll have fewer closing costs.
- This type of mortgage is more flexible. You can negotiate with the seller the terms and conditions of the loan.
- If you have poor credit, cash shortages, or don’t qualify for other types of mortgage loans, you can benefit significantly from VTB.
- VTB is best for purchasers in a buyer’s market (rare in Canada). Vendor financing will work best where there are many houses and realtors having difficulties moving their stock.
VTB Cons For Buyers
- The VTB is another mortgage on the home you’ll need to pay back.
- The bank has the right to prevent you from taking a VTB loan. The bank is still a lender and has the option of refusing to lend you money if you are getting funds from someone else.
- The seller would want to have enough equity in the property to cover what they are lending you —i.e. if the VTB is for 10% of the buying price, the seller needs to own 10% of the home.
- If you are receiving VTB funds to purchase a home, you probably won’t be able to avoid mortgage default insurance, which will add an extra payment to your home-buying costs.
Advantages Of VTB For Real Estate Investors
Since the Vendor Take-Back Mortgage suits better for an affluent real estate investor or someone with prior real estate experience and high-risk tolerance, this tool appears more in the real estate investment world.
If you own properties entirely, they may be subject to significant capital gains taxes if you decide to sell them. A VTB can help you avoid capital gains from the buying price, which will give you considerable tax benefits. The monthly mortgage payments are an additional income source.
Investors with poor credit can also take advantage of the VTB using it as a short-term financial alternative until a better solution is found. They can use the VTB mortgage payments to improve their credit, establish a good payment history, and build equity in the home to eventually get a better financial arrangement with a more attractive interest rate.