This is a common concept in commercial real estate, but rare in residential transactions.
A public misconception is that VTB is a shady form of business used by unsavory people to bridge the gap between fair market value and the outlandish price the vendor is charging you. However, the reality is it could be one of the safest and best options for both the buyer and the seller.
In early years, it was a common tool in residential properties, but it went by the wayside with the advent of mortgage insurance. First arrived banks could only lend 75% of the appraised value. But insurance (at what I feel is a substantial cost to the buyer- up to 95% or more of appraised value) is available. Over the years, changes have occurred and banks now lend 80% of appraised value and other small changes have helped refine the practice, but the end result is the VTB in residential properties is gone, and that is a mistake.
Commercial mortgages, on the other hand, are far more difficult to obtain, cost substantially more and require a far greater down payment. It is my experience on my first call to any lending institution is that commercial lending is at one to two percent higher than residential and require a 20-25% down payment. But when we actually sit down, the down payment can jump to 50% and the interest rate is climbing like a six year old child in a tree! The buyer now has a problem, hence the VTB.
The truth of the deal is more sales are motivated by retirement or the owner has other interests. However, they have spent many years running the business or living in the home and nobody knows it better. And to the buyer, to see the seller willing to invest in the purchase gives a confidence you can’t replace.
As an example, I was asked to appraise a farm recently for a mother- to- son transaction. The land, machinery, cattle and all other aspects came to about $4,500,000.00. The son was already a third owner and he was the fifth generation. The mother decided that $750,000.00 was all she needed to retire, so the price was agreed upon. The son then went to farm credit and borrowed the funds at 6%. The lady went to her local bank where she had banked for years and asked them to invest the entire amount. When I talked to the lady a little over a year later, the market had declined and her equity was somewhere between $600,000.00-$650,000.00, and understandably, she chose not to talk about it.
It clearly would have been a better deal had she lent her son the money at the going rate.
This same scenario has played out many times in my career and I’ve often wondered why. As far as I can tell, after a person has worked their whole life, they just want to see their hard-earned money and the VTB just does not seem real. As an old farmer used to say to me when I was a boy, don’t bother me with the facts, my mind is made up.