What is 'Vendor Financing'? (and why does it matter?)

Although 'Vendor Financing' is a relatively simple concept, it is often confused with other very different things, like 'rent to own' or an 'option to purchase'. It is interesting that many otherwise savvy and experience home owners and real estate consumers- really don't understand what 'Vendor Financing' is, and why it could or should be considered, and the pros and cons.

But before we get to what 'Vendor Financing' is- let's review a VERY important real estate concept that is often forgotten. A good deal is not just based on the purchase price. I will say that again... it isn't just about PRICE. Unless you have millions of cash in the bank that is not invested- money has value! In real estate transactions both PRICE and TERMS combined to determine if it is a good deal or a smart purchase. If you got a great price, but you had put all of your savings into it and the rest of purchase was financed with credit cards with 21% interest and high monthly payments; is this really a good deal? Is it sustainable?

What is 'Vendor Financing'?

In the simplest terms, 'Vendor Financing' is when the seller of the property provides mortgage financing to allow the new buyer to purchase the property, usually as a first mortgage, but sometimes as a second mortgage (if the buyer is already getting a first mortgage). The key point- the property is transferred, ownership changes hands, the buyer becomes the owner and the seller becomes a lender. Sometimes 'Vendor Financing' is called 'Vendor Take-back' or 'Seller take-back'. 

'Vendor Financing' is very different than other schemes like 'rent to own', 'option to purchase', or 'contract of purchase' where the ownership stays in the original owner's name (which presents big risks for a potential buyer as they have no control over whether the original owner is paying mortgages, taxes and is going to honour whatever agreement they have struck). There is also considerable risk for a seller as the buyer has very little or no "skin in the game". Considering the risks and how one sided many of deals will be, and how risky they are, I will not recommend or help clients get involved in one of these schemes.

An important point around 'Vendor Financing' is that it isn't forever. Although the amortization might be for 20 years or longer, almost always the seller will want the mortgage term to be much shorter, anywhere from one to five years, and then they want the buyer to refinance and pay them out the balance in a lump sum. Call it the 'light at the end of the tunnel'.

Advantages for a Buyer?
  • Lower Down payment: Often a 'Vendor Financing' purchase will involve a lower down payment than a traditional lender expects, this is especially relevant in commercial and land deals where many lenders want 50% (*$%*%??) down. But it can even be relevant in residential deals where a seller may accept a flat amount down payment, like $10,000 or $20,000, which could still be significantly lower than the standard uninsured down payment of 20%
  • Traditional lending not an option: Whether it is because of bad credit, no credit, weak paper earnings (debt service ratio issues), incomplete financial information (taxes haven't been filed for awhile); there are lots of reasons why traditional lenders will say no to lending
  • Quick Closing: Without the need for appraisals, sales with vendor financing can generally be organized quickly and with less closing costs and complexities
Disadvantages for Buyers?
  • You need to Refinance: There has to be 'light at the end of the tunnel' and the ability to refinance in the agreed upon term. Whatever the reason that traditional lending won't work today, there has to be a compelling reason why this will be a different story in the future
  • Perhaps the property in question is a 'lemon' and the price is too high and attractive terms are the only way the seller can get out?
Advantages for a Seller?
  • Income Stream at a good rate: If a seller has no immediate plans for the sale proceeds (other then perhaps investing it with record low returns in safe investments), making a monthly income at a decent interest rate in an asset they are familiar and comfortable with, isn't the worst idea; especially if it is only for a few years
  • Transfer of work and risk: Especially for an income property, by selling the asset the seller is no longer responsible for managing tenants, taking the risk of vacancies, doing maintenance and upgrades. If the seller is elderly, shifting some of this work and responsibilities onto a potential younger buyer can make a lot of sense
  • The property isn't selling for cash at the desired price. Sometimes a seller has a firm sale price in mind, sometimes that price might above market, but having the right terms can make it attractive enough to get a deal in place
Disadvantage for a Seller?
  • Foreclosure: If the buyer doesn't make the payments or doesn't refinance on time, getting the property back is not automatic, there is a definite and complex process to either offer the property for sale in a court ordered sale process or to take back ownership. 
  • Lack of liquidity: If something unexpected comes up and you need a lump sum of money immediately, you don't have it. And selling the mortgage to another investor will likely result in a big discount off of the face value of the debt.

The most likely situation where 'Vendor Financing' will work well for a both a buyer and seller is one where:

  • The market for the particular property is not "Hot", there are no immediate cash buyers coming at the asking price
  • The Seller has no debt on the property and no immediate plans or needs for the bulk of the sale proceeds
  • The Buyer has a compelling reason or narrative why traditional lending doesn't work for them, they are trustworthy and seem worthy of being "helped"
  • Usually the Seller will be older and the Buyer will be younger 
Vendor Financing won't work in every situation, and definitely will not work in a hot market or a hot property with multiple cash offers coming forward. Each situation is different, but with a lot of experience both buying properties personally with vendor financing, and helping to arrange vendor financing purchases and sales for my real estate clients- I am happy to help if you have questions or want to learn of some properties which might be available with 'Vendor Financing' in place!