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Archive for the ‘Vendor Take Back Mortgages’ Category

Vendor Take Back Mortgages – More Details…

Tuesday, November 9th, 2010

Transcript of Video Blog:

Hi, everyone, Rowan Smith with the Mortgage Centre. I want to talk today about vendor takeback mortgages. I’m getting a lot more inquiries no them, and there’s a fundamental misunderstanding out there about how they apply and whether or not you can really use them.

A lot of the no-money-down programs, Carlton Sheets and all these other guys that are out there, have been using vendor takeback mortgages. Those programs are predominantly American. Now the technique does work here, but it’s not as simple as people think.

What they’ll often say to me is, “Rowan, I want to buy a $400, 000 house. I don’t have the 5% down, so I want to take a vendor takeback for the 5%.” What that means is that the seller is loaning you the 5% down payment.

Sounds good. The only problem is, it’s not allowed. You can’t do it under Canadian banking systems, because to do 5% down, the person who’s got the first mortgage either has to get CMHC, Genworth, or Canada Guarantee in mortgage insurance, most commonly CMHC.

CMHC is not going to allow you to borrow 5% behind their 95% financing. Part of it’s just simple risk. Knowing that you have absolutely no money in the deal and have nothing to lose if you walk away doesn’t give them a lot of security that you’re going to make your payments.

But secondly, you end up borrowing more than the purchase price. And the reason is, when you pay, put 5% down, you’re going to be looking at a mortgage insurance premium through CMHC for Genworth or Canada Guarantee of anywhere between 2.75% and 3.35%, depending on what program you buy through.

So if you’re looking at 95% financing plus the additional funds for the premium, you’re up at 98% financing. Now you’re going to add your 5% that you’re getting from the vendor. So you’re up over 100% of financing. They’re simply not going to allow that.

And while the math may make good sense, or it may make sense to your realtor or advisor why you can do this, it’s realistically not going to happen in Canadian real estate. I’ve seen too many applications where people have tried to do a vendor takeback, and it’s really considered a dirty word in the industry at this point.

So if you’re thinking of a vendor takeback, the only time you can really do it are on commercial transactions or when you already have a very sizable chunk of money from a percentage standpoint, 20%-plus for example, and are looking to maybe top that up by borrowing a bit back from the vendor.

There are number of ways we can structure this, and I can help you do that. If you have any questions on vendor takebacks, please call me with your situation, let me go through it with you, and we’ll see if we can make it work.

For the Mortgage Centre, I’m Rowan Smith.

Vendor Take Back Mortgages – Take Back – 2nd Mortgages

Saturday, September 11th, 2010

Transcript of Video Blog:

Hi, everyone. I want to talk today about something — I haven’t done a blog post for quite a while — and that’s vendor take-back mortgages. What is a vendor take-back, and when does it apply?

A vendor take-back is essentially a situation when the vendor agrees to take back a mortgage in lieu of some cash. I’m going to give you a really clear basic example, but then I’m going to show you what everybody always wants and why it rarely works in Canada. It works in the United States quite smashingly, but it doesn’t work so great up here north of the border.

So, a vendor take-back: if you assumed that a guy wanted to buy a piece of property that was $400,000 but he didn’t really have a down payment, what he could do is go to that vendor and say, “Listen, what I’m going to do is I’m going to get $20,000 from someone over here. Will you carry the balance of the mortgage?” meaning, will you loan me the money and take the property as security?

Now not all sellers are going to be willing to do this. First off, they’re going to want an interest rate, probably higher than the bank’s, to make this worth their time. Secondly, they have to not need those dollars to go buy something else because they haven’t received them from you. You borrowed it from them.

That’s a standard vendor take-back situation. I’m dealing with a guy out in the country right now who bought a house with a massive shop on a huge piece of acreage. The banks didn’t want to finance it because the house is old and rundown, and he was buying it purely for an 8,000 or 10,000 square foot shop that was on it that was wired up for his business. For him, it made great sense.

The vendor was an old guy. The vendor agreed to lend him 100% of the purchase price. Great, he can do whatever he wants, but he’s got to pay that guy the interest. Eventually, as he accumulates money from running his business, he’s going to have to get a mortgage from somewhere to pay that guy out, because that guy’s going to eventually want the dollars.

But here’s the situation we run into frequently where people think a vendor take-back would work. They know they need to get 20% to buy a rental property, so what they say is, “Well, why don’t I put 10% that I have down, and then the vendor gives me 10%, and then we get the other 80% from the bank?”

The reality is that banks generally don’t go for this setup. They don’t want to see vendor take-backs, because if they do, they now have to factor in that payment and can the person afford the vendor take-back payment, the mortgage payment, plus any other debt payments.

If they can, great. Then there might be something we can do. But in the 10 years that I’ve been doing mortgages and banking, I’ve never seen that situation once. So you generally need 20% of your own equity before a vendor take-back becomes an option.

Now you say, “Look, I’ve got 20%. What do I need the vendor take-back for?” Still, 80% is still a pretty high amount of financing, and if your property’s unique or your situation’s difficult with credit or income, maybe you’re going to need 35%. So you’ve got 20; you need 35. Where’s the 15 come from?

That’s a circumstance where a vendor take-back might make sense, and it may be a situation where we can use it. But I need to look at the situation as a whole, because the property, the source of your down payment, and your income and credit all form a very integral piece of the puzzle, and we’ve got to look at that together.

From the Mortgage Centre, I’m Rowan Smith.

Vendor Takeback Mortgages – Why They Rarely Work in Canada

Monday, November 30th, 2009

People call me all the time wondering if they can use a vendor take back mortgage on the purchase of their new home. My knee jerk reaction is NO, but there are exceptions. I did the following video blog explaining why the vendor take back doesn’t work that well.

Enjoy!

Vendor Takeback Mortgages – Are They All They Are Cracked Up To Be?

Monday, March 23rd, 2009

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.

DEFINITION:
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.

With the high price of homes in Vancouver, people usually ask if they can do a vendor takeback for only 5% or 10%. With a home price in Vancouver of around $720,000 (on average for a single family home) 10% down is $72,000! This is a considerable amount to ask a vendor to “carry” or lend back as a vendor takeback on purchase.

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.