What is a Vendor Take Back Mortgage?
With interest rates rising and the real estate market cooling, some buyers have found themselves in a tricky situation. They’re no longer able to get the mortgage they previously qualified for, which has left some of them wondering what is vendor take back mortgage?
A vendor take back mortgage is not a common type of mortgage. In fact, it’s not even offered by financial institutions. That said, this type of mortgage can help people who are short on funds even after negotiating the purchase price. Keep reading to find out more about what is a vendor take back mortgage.
What is a vendor take back mortgage?
A Vendor take back mortgage, simply known as VTB, is also sometimes referred to as a seller take-back mortgage. Basically, if the seller owns the property outright, they can lend the money to the buyer to help complete the transaction. This is not a traditional mortgage, which is why you don’t hear about it often.
Since the VTB becomes the mortgage lender, the buyer is now the borrower. You pay back the mortgage based on the contractual obligations and loan terms you have set with the seller.
A VTB is only possible if the seller owns the property outright. If the seller still has a mortgage, they won’t be able to offer any seller financing.
Types of VTB financing
VTB Financing has two available options: partially-funded and fully-funded. What you decide on is a personal choice and what the seller is offering.
Partially-funded VTB mortgage
As the name implies, a partially-funded VTB mortgage, is where the seller of a property offers you limited funds to cover the remaining portion of the mortgage that you could not secure.
For example, let’s say you’ve purchased a home with a sale price of $650,000, and you have a down payment of 20% ($130,000). That means you need a mortgage of just $520,000. During the appraisal process, the bank says the home is worth only $575,000, so they’ll only lend you $445,000. That means you’ll be short $75,000. Assuming the offer was unconditional, you’re still on the hook for the remaining amount.
You could borrow money from family or use a private lender to make up the difference. However, the seller may offer you a VTB to cover the remaining principal amount at a lower rate. If you accept, you’d have two mortgage payments. One would go to the traditional lender and the other to the seller.
Fully-Funded VTB mortgage
While rare, fully funded VTB mortgages occasionally happen. For example, in a buyer’s market, a seller might offer a VTB with favourable terms to help someone who wouldn’t normally qualify for a traditional mortgage.
No money would be exchanged when the transaction is completed, but the VTB mortgage would be the primary lien on the property.
Canadians require at least a 5% down payment when purchasing a home, so a fully-funded VTB mortgage could only cover the remaining amount. You can’t borrow money for your down payment.
Why consider a vendor take back mortgage?
Admittedly, some people will wonder what’s the point of a VTB mortgage when they can go to a traditional lender instead. Well, if things were that simple, the purchaser wouldn’t be asking what is a vendor take back mortgage.
Since mortgage rates have gone up, the cost of borrowing money has also increased. In addition, since the housing market has cooled, home appraisals aren’t coming in as high as they used to.
Some purchases are no longer able to secure enough funds to cover the entire agreed price. With a VTB, or second mortgage, you’d pay a higher interest rate than traditional lenders, but it would be lower than private lenders. So by getting a VTB mortgage, both sides could complete the transaction more quickly.
Pros and cons of a VTB Mortgage
It’s time to go over the pros and cons in this what is a vendor take back mortgage guide. As you can imagine, a VTB is not for everyone, so you need to consider both sides before making a decision.
Pros of a VTB mortgage
- Helps close the deal – When financing is the hold up for securing a deal, a VTB could help complete the transaction.
- Potentially lower interest rates – The seller may offer a lower interest rate than a private lender. This is good for the buyer since their monthly payments will be lower. It also helps the seller since they get monthly payments with a fixed interest rate.
- Helps people with a low credit score – Some people with a poor credit history but stable income may struggle to secure a mortgage. If you’re offering a VTB mortgage, you can decide your risk tolerance.
- Defers capital gains – A VTB on commercial properties and investment properties allows you to defer and spread tour capital gain taxes over five years
Cons of a VTB mortgage
- You’re in the second position – When offering a partially-funded VTB mortgage, you would have the second lien on the home. That means if the buyer defaults, the traditional lender gets paid first.
- Must own your home entirely – You can’t offer a VTB mortgage if you still own a home
- Limited use – A VTB mortgage only makes sense in specific situations.
- Opportunity loss – With a VTB, you’re not getting the entire amount for your home right away. That means the equity you could have cashed out on is tied up, which prevents you from taking advantage of other investment opportunities.
- Extra paperwork – Anyone offering a VTB mortgage becomes a lender. That means you’ll need a real estate lawyer to help you draw up the paperwork.
Final thoughts
Now that you know what is a vendor take back mortgage, you need to think about the key takeaways. While the benefits of a VTB mortgage are pretty clear from the buyer’s perspective, most sellers likely won’t be interested in making an offer. First, they need to own the property outright. In addition, they take on a lot of risks. If the buyer can no longer make payments, it could be a long process to file for foreclosure. That said, in the right situation, a VTB could benefit both sides of the deal since it does offer some flexibility.
