What is vendor finance?
Vendor finance means borrowing money from the seller when buying a property. These arrangements aren’t as tightly regulated as regular home loans provided by a bank or non-bank lender. This may make it easier to apply and get approved, but there are typically also far fewer consumer protection rules the financer must abide by.
How does vendor finance work?
Vendor finance is a term encompassing any loan from the seller of a property to the buyer.
Traditionally, when a buyer takes out a home loan, a bank or lender ensures they pass through a rigorous (and regulated) application process to check if they can afford to pay back the loan. By contrast, in vendor finance arrangements, the loan is typically arranged privately, potentially with less formality, and without notable protections for the borrower.
In Australia there are three main types of vendor finance arrangements:
‘Wrap-around loan’
A ‘wrap-around loan’ means the seller has a mortgage on the property and the buyer makes repayments to the seller to pay off. It’s called a ‘wrap-around’ because the buyer's loan is ‘wrapped around’ that of the seller.
If you take on a wrap-around loan, you’ll typically pay the seller in regular instalments like a normal loan, at a higher rate than they’re paying.
Rent-to-buy
Rent-to-buy means initially renting a property for a period of time, with your payments said to be going towards building up your equity. Once the rental period is up, you have the option to buy the property at a pre-agreed price, minus the equity you’ve already built. The seller remains the legal owner until they receive the full sale price.
You might still need to put down a 1-3% deposit at the start of the rent-to-buy period, which might not count towards your equity. If you do decide to buy, you’ll likely still need to take out a traditional home loan after the rent-to-buy period finishes and, if you or the property can’t qualify for a mortgage, you’ll likely lose all equity you’ve amassed.
Since rental payments also normally include an ‘option to buy’ fee, you’ll probably pay more week-to-week than you would have for a standard rental.
Financed deposit
Some buyers combine vendor finance and a normal home loan by borrowing their deposit from the property seller. This might mean applying for an 80% loan-to-value (LVR) home loan from a lender (to avoid lenders mortgage insurance) and borrowing the rest of the funds needed from the seller, leaving you with two loans to pay off simultaneously.
Why use vendor finance?
Scenarios where you might consider vendor finance might include:
- You don’t have enough money for a deposit
- You can’t provide conventional proof of income
- You have a poor credit score and traditional lenders are reluctant to write you a loan
Is vendor finance a good idea?
Vendor finance has been criticised over the years for exploiting vulnerable buyers, including in the 2017 Royal Commission into the Australian banking sector. Vendor finance is restricted in some states and territories, with rent-to-buy schemes banned in Victoria and South Australia.
Some of the potential issues with vendor finance include:
- Buyers may pay well above what the property is worth, so may end up selling at a loss or find themselves unable to refinance in the future
- There aren’t the same consumer protections as offered by regular mortgages
- Both parties’ rights are often unclear as agreements can get incredibly complicated, which can mean the buyer might find they don’t actually end up owning the property
- There’s often confusion around who pays for council rates, land tax, insurance, and other related costs.
If you’re considering seeking out vendor finance, you should make sure you get legal and financial advice from a qualified professional beforehand.
