I take inquiries and questions from clients about Vendor Takeback Mortgages on a weekly basis. The purpose of this blog is to both clarify what precisely a Vendor Takeback Mortgage is, and where it is, and is not, helpful in arranging financing.
First, it is important to be clear what we are taking about. A Vendor Takback mortgage is one where the vendor “takes back” a mortgage when they sell a property. So, let’s use some round numbers to help this make sense. In this case, the home purchase price is $100,000.
If a vendor (seller) agrees to “take back” a $20,000 mortgage (for example) this means that the buyer has to get $80,000 of financing from the bank, and the vendor will register a 2nd mortgage for $20,000 behind the bank financing.
The first question is, “why would the seller do this?” or “why would the buyer want this?”
Typically, vendor takebacks get requested when the buyer doesn’t have a down payment, or enough of a down payment. If a buyer sees a property that they really want, but they don’t have any cash available for a downpayment, then how do they get one? They borrow it, and in the case of a vendor takeback, they borrow it from the seller!
The reason a seller would agree to do this (effectively lending $20,000 to a buyer) is because they will usually get a superior rate of return (often greater than 10% per year interest) than they would get otherwise in term deposits or other secure investments. For example, if bank rates on mortgages are 4.09% for the first $80,000 then the seller may request 12% for the $20,000 (for example) vendor takeback. This would mean the buyer would have a monthly mortgage payment on the $80,000 he borrowed from the bank ($424.5 per month assuming a 25 year amortization). Then, the buyer would also have a payment to the vendor for $200 per month (assuming interest only at 12% per year on the $20,000 vendor take back).
Now, clearly, the payment for the vendor takeback is higher, due to interest rate, than the bank mortgage. You may find yourself asking, “so why would anyone do this?” The answer is, 99% of the time, they don’t have the cash for the down payment. In this manner (vendor takeback) they are able to buy a property, with essentially no money out of their own pocket.
In this case, at the closing date, the buyer would get his $80,000 for the bank and turn it over to the seller, and the bank would register a mortgage against the property as security for $80,000. Then the seller would effectively take a $20,000 IOU (registered as a 2nd mortgage) instead of the balance of $20,000 in cash. The sale price of the property is still $100,000, and eventually the buyer will have to pay that money, but they are essentially borrowing the down payment from the seller in exchange for paying a higher-than-bank-rate return.
Sounds great? Not really.
My example above makes a couple of assumptions that may or may not be true.
The assumptions are:
1. The seller has to have the $20,000 in equity in the property, AND be willing to lend it (i.e. not need it to buy another home) at the agreed-upon rate.
2. The bank doing the $80,000 mortgage has a right to prevent the vendor takeback mortgage from being registered at the closing date.
3. My example presumed a 20% vendor takeback (to avoid CMHC insurance fees) but usually vendor takebacks are much smaller (percentage-wise) as vendors (sellers) don’t want to lend that much, or don’t have that much equity.
4. There are still closing costs that must be paid in cash such as property transfer tax, legal bills, adjustments, etc… that were left out of the example for simplicity.
5. There was still a payment required on the vendor takeback mortgage that the buyer has to be able to afford.
Let’s address each of these in turn as they are important considerations:
SELLER MUST HAVE THE EQUITY AND WANT (BE ABLE) TO LEND IT
If the seller doesn’t have the $20,000 of equity built up in the property, then they cannot do the vendor takeback even if they want to. They have to have the money in order to lend it! Also, the seller of the property is likely going to go and buy another property (although not necessarily). In order for them to be able to do a vendor takeback, they have to have enough alternative resources to buy their next home assuming they buy one.
THE BANK MAY NOT ALLOW THE VENDOR TAKEBACK
The bank doing the 1st mortgage may or may not allow a second to be registered. This depends on the lending institution, but most chartered banks do not allow secondary financing to be registered at closing. Why? Because they perceive the additional mortgage (and payment) as increasing the overall risk of the deal. If the client qualifies for the mortgage traditionally, why not borrow it from the bank at bank rates? The reason is that people often look for a vendor takeback when their bank won’t approved them for more money due to income, credit, or some other policy reason. As a first mortgage lender, the bank (or whomever) is doing the 1st mortgage has a right to dictate whether or not secondary financing (vendor takebacks) is available or not. This is just the way it is. If they are going to lend, in our example, $80,000 then they have the right to dictate the terms of the financing, and nearly ALL banks do NOT allow secondary financing.
That point bears repeating: MOST BANKS DO NOT ALLOW SECONDARY FINANCING. There are exceptions, but most banks insist that at least 5% or 10% of the purchase price come from the buyer’s own resources. There are no chartered banks, that I am currently aware of, that will allow 100% financing by way of a vendor takeback. None. Unless policies have changed recently, there are no banks that allow 100% financing by way of a vendor takeback. Why? Because the government recently mandated that the 100% financing be cancelled and the banks all support this ruling.
CMHC FEES USUALLY WRECK THE PARTY
In many cases, the vendor doesn’t want to do a 20% (or more) vendor takeback. In Canada, if you have less than 20% equity, then bank will charge you CMHC fees (mortgage default insurance that, if you default, the bank gets paid out of the insurance fund). These fees are NON-negotiable. They are law.
Let’s continue with our simplified example of $100,000 purchase price and see how a vendor takeback applies (or doesn’t apply). If the buyer requests a 5% vendor takeback, and gets 95% financing from their bank. Here is how the numbers look:
$100,000 Purchase Price
$95,000 1st Mortgage
$2,612.50 CMHC Fees (added to mortgage)
$97,612.50 Net Mortgage (97.62% financing)
$5,000 Vendor Takback Mortgage (5%)
5% + 97.62% = 102.62% financing (oops… over 100% financing isn’t allowed in Canada)
So, as you can see, CMHC fees, when added to the mortgage (they are added to the mortgage 99.9% of the time) force the financing higher than the original 95% amount. With the vendor takeback, we now exceed 100% and no bank in the land will allow this.
The only way that this MIGHT be allowed, is if a person pays the CMHC fees out of their pocket. However, if that have that cash laying around, they usually want to put it as a down payment to avoid paying interest. I have never had a client, in nearly 10 years of banking and finance, pay CMHC fees out of their own pocket. While technically possible, people usually just don’t do it.
The lesson to take away from this is that CMHC fees usually mess up the financing plans. So, unless you can talk a vendor into lending you 20% or more (or have some of your own equity plus a vendor takeback to sum to 20% of the purchase price), CMHC fees will screw up the plan. This is usually a moot point as most banks insist on 10% of your own equity into the deal. They want to see that you have some “skin in the deal” and stand to lose if you walk away just like they lose if you walk away or get foreclosed on.
THERE ARE STILL CLOSING COSTS TO BE PAID IN CASH
Even if you manage to get a vendor takeback, there are still closing costs to be paid. You can’t borrow more than 100% so you can’t “roll it into the mortgage.”
For example, on our $100,000 purchase, assuming you don’t qualify for the first-time homebuyer exemption for transfer tax in BC, the closing costs you will face are:
$1,000 Property Transfer Tax
$1,000 Appoximate Legal Costs
$1,000 Move-in fees, utility transfers, miscellaneous fees
$250 Adjustments for property taxes, etc…
$3,250 of CASH you will need to have access to at
THE VENDOR TAKEBACK WILL STILL HAVE A PAYMENT
People often say to me, what if the vendor takeback is from my parents. They will sell me their property, and give me the 20% of down payment (to avoid CMHC fees) but they will do it interest free with no payment so we can qualify for the 1st mortgage with the bank. Even if they don’t charge interest, and have no payment, the bank doing the 1st mortgage will ALWAYS make an assumption of a payment when qualifying you. This is a point of bank financing you just have to learn to accept. Even if the vendor takeback is done with 0% interest and no monthly payment, the bank will ASSUME YOU STILL HAVE A PAYMENT WHEN QUALIFYING YOU.
This point often makes first time homebuyers upset, but it is something that I’m yet to see an exception made on. I’ve never seen a charterd bank allow a vendor takeback with 0% and no payment without calculating SOME form of payment into the calculations on the 1st mortgage. When the bank is qualifying a buyer for the 80% 1st mortgage (or whatever amount it is) they will “plug in” some number for the vendor takeback mortgage payment, even if it doesn’t exist. This is just a conservative move that the banks do to ensure a buyer can realistically afford a mortgage (and vendor takeback if the parents or vendor change their mind and charge interest later on – something the bank has no control over once the mortgage funds).
SO WHERE DO VENDOR TAKEBACK MORTGAGES WORK???
So, I’ve spent the last 95% of this blog post, and video blog, explaining why vendor takebacks don’t work. So when do they work?
Typically, I see vendor takebacks on commercial deals. This is because on a commercial deal, all the rules I talk about above don’t apply. For this reason, I see them on large land deals, massive development projects, and commercial property purchases. If your purchase is of a commercial nature, talk to me about how to set up a vendor takeback with the seller as our options expand exponentially.
Based on the rules I’ve described above, if you have 10% down, and can get more (say 10% more) so that you can avoid CMHC fees, then we may be able to work something whereby you can get a vendor takeback. If you are in a position to come up with 20% down payment (whether from own resources or from a vendor takeback), please call me or email me to discuss how to structure this. I can assist you (or the vendor) with the mortgage document preparation and can advise all parties as to the risks and rewards of such a structure.
BOTTOM LINE: With the current bank restrictions, rules, and market panic, vendor takeback mortgages are difficult to structure and make a deal work. However, they ARE possible – and are particularly workable within a family looking to assist children buy their first home. Contact me for more detail and we can discuss a structure that works for you.