When buying a residential property, most purchasers typically do not have sufficient funds to make an outright purchase.
While a majority of purchasers will look towards banks and other conventional lending institutions to loan them the necessary funds, they can sometimes find their loan application rejected on several grounds.
This usually happens when the purchaser does not have the minimum required funds to make them eligible for the mortgage loan or if the purchaser has earlier defaulted on a previous loan.
In such cases, the purchaser has another option for funding the purchase of his residential property and that is to take a loan from the vendor itself.
This is called vendor finance.
How Vendor Financing Works To help us understand how this transactions works, we will draw an analogy from a land owner or vendor who may want to sell their residential property to a potential purchaser.
If the purchaser does not have the capacity to purchase the residential property outright, he or she may agree with the vendor that the purchase price will be "increased" based on a pre-determined set of terms and conditions.
Very often, the contract of sale will state that the title to the property will remain with the vendor and will only pass when full payment of the amount outstanding is paid by the purchaser.
Typically, purchasers can expect to get vendor financing of up to 80 percent of the purchase price.
Similar in principle to lay-by transactions where repayments are made, the difference in vendor finance is that the purchaser can actually reside within the property while making the repayments.
Generally, an investor will buy the property at a lesser market value and negotiate with a home buyer who will purchase it at market rates and in accordance to the agreement arrived at with the vendor.
The whole idea is that the investor will earn a little extra money from interest and the higher sell price.
These will "wrap" the expenditures of the investor.
This can be compared to charges or mortgages as forms of securities used by banks.
Discharge of these charges or reconveyance of these mortgages depends on the repayment of any outstanding loans.
Just like in these two, the interests of the parties are protected by well laid out legal instruments including caveats and inhibitions and right to sue on covenant.
These will limit the transfer of the title to the property to the purchaser until the rights of the legitimate parties in the contracts have been catered for.
In case of the purchaser breaching the contract the vendor financier has the right to commence legal proceedings against the purchaser and the contract will stand annulled.
The contract also protects the purchaser by disallowing the vendorto further borrow against the property or to sell it without proper advance intimation to the purchaser.
Advantages of Vendor Finance for Property Investors It is possible to deduce the following advantages of this scheme to investors from the above discussion and everyday practice as follows: • It will allow property investors to tap into the large pool of home buyers • Both the purchaser and buyer gain through the use of this instrument • Long-term cash flow is guaranteed for the investor • As the property investor, you do not need to maintain the property as this is the mandate of the purchaser •It is possible to qualify for government grants as an investor