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Often referred to as seller finance, vendor finance is an alternative way to buy a home without having to take out a mortgage with a bank or lender. Vendor finance is a fancy name for a situation when the seller of the property "loans" you the money (or part of the money) to buy their property. It generally appeals to people who have poor credit or a poor employment history, or you’re unable to qualify for a traditional home loan for any other reason.
The purchaser and vendor arrange the finance terms privately rather than through the banks, and the purchaser pays off the purchase price of the property via instalments to the vendor. Because this happens as more of a private arrangement than a transaction through a bank or lender, there are a number of risks you need to be aware of.
While these agreements are normally established over a 30-year term, the intention is to pay out the contract as soon as the purchaser is in a position to refinance the debt through a conventional home loan.
Vendor finance provides the buyer with the opportunity to finance a property through an alternative means. Essentially, it helps borrowers who are not “finance ready” by allowing them to access finance and pursue home ownership with flexible terms.
However, vendor finance carries with it a number of risks. A study by the Consumer Action Law Centre found vendor finance schemes were often detrimental to would-be buyers, and commonly ended in buyers being unable to complete their purchase. Before entering into any agreement, you should consult a solicitor.
With vendor finance, the buyer normally pays a small deposit to the seller and makes repayments to the seller over time. These repayments may or may not include interest, and the purchase price (and therefore the repayments) are typically higher compared to a standard loan.
For instance: a standard home loan may come with an interest rate of 2.5%, but the vendor finance provider charges 4%. Or the property would normally sell for $500,000, but you agree to pay an inflated price of $550,000.
Depending on the individual agreement, you will either have the option of paying the instalments until it is paid off in full or you will make the repayments until you’re in a position to qualify for a mainstream mortgage, in which case you’ll refinance and pay off the balance in a lump-sum payment.
Generally, this would occur 2-5 years after moving into the property. As it’s likely that you’ll need to refinance with a bank at some point, you need to ensure that you can meet the repayments, save enough for a deposit and maintain a good credit rating to qualify for a home loan during this time period.
Should everything work according to plan, once you’ve made the last repayment, you assume ownership of the property. However, such agreements often end with buyers losing the funds they've put toward their home.
There may be some situations in which vendor finance could be a viable option, including:
Vendor finance carries some significant risks, many of which may far outweigh its potential benefits.
There are three common forms of private vendor finance, including:
It depends on the vendor and the agreement you enter into. It may be possible to purchase the property with no deposit. But you will generally be required to hand over a deposit of around 2-5% of the property purchase price. This compares favourably to a 10-20% deposit required by most Australian lenders for a standard mortgage product.
The same fees and taxes are payable with vendor finance as they would be with a standard home loan. However, the additional complexity means more legal work and higher costs than would normally be associated with a traditional mortgage product.
While vendor finance may seem like a potential solution for borrowers who have trouble saving a deposit or fall outside lenders' criteria, the risks involved can far outweigh the potential benefits. Before entering into any agreement, it's crucial you seek the advice of a solicitor and make sure your interests are protected. However, considering the risks, vendor finance may be too fraught with potential pitfalls to be worthwhile.
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