Real Estate Transactions and Vendor Take Back Mortgages
How to Protect Yourself as a Seller
Traditionally, a buyer makes an offer to purchase a property and arranges financing through a lender (the usual primary lenders include CIBC, TD, RBC, Scotiabank and BMO to name a few). These institutional lenders typically offer fair interest rates, fixed or variable options. Poor credit scores, other debts and inconsistent income are factors that can lead buyers to search for alternative sources of financing which include “B list” lenders or private mortgaging. One of these alternative sources of financing that is gaining recognition in today’s shifting real estate market is a Vendor Take Back Mortgage (VTB).
What is a VTB?
A VTB is a form of mortgage where the seller loans the buyer a portion or all of the funds to purchase the property, eliminating or reducing the need for a bank to advance a loan. If the buyer is unable to make the mortgage payments to the seller, the seller retains the same rights as a bank to force a sale of the property to recoup what is owed.
In this current financial climate, many prospective buyers are finding themselves locked out by big banks, as property prices increase, financial regulation of traditional mortgages increases and the appraised value of the property falls short of the agreed upon purchase price.
What a Seller Needs to Know/ How to Mitigate Risk
- VTBs require financial risk
When considering a VTB, a seller needs to consider the big picture of their financial situation. VTBs often offer higher interest rates than a traditional mortgage and can be a great financial move for a seller. With higher returns on investment than average investment opportunities, if a seller can afford to stagger the proceeds of their sale over a longer period of time, they can come out ahead. However, VTBs are not for the cautious individual. They require a certain degree of financial risk. For a sophisticated investor or wealthy individual, it can be a great investment. An individual should be extremely hesitant to wrap up their retirement nest egg in such a transaction.
Sellers should protect themselves by doing a full financial risk analysis before agreeing to a VTB.
- Know Your Priority
If a seller agrees to a VTB in second position because a bank is unwilling to cover the full purchase price, they must know that a first mortgage will always outrank a second mortgage. If a purchaser is unable to make their mortgage payments, the order of registration determines the order of repayment. Circumstances and markets change. Just because someone was willing to buy your property for $1,000,000 does not mean that on foreclosure it will sell for the same. If the property sells for $700,000 on foreclosure, and the first position lender is owed $750,000 on the first mortgage, you, if a second position lender, will be unable to recoup your losses. This is something that is essential to be aware of when calculating the risk of such a transaction.
Sellers should protect themselves by understanding the implications of their repayment priority before agreeing to a VTB.
- Do not be a dupe to fraud
The unfortunate reality of private mortgages (such as a VTB) is that they may attract criminal opportunists. There are many advantages for criminals in using private mortgages like VTBs over mortgages from banks. Red flags or signs of fraud that a bank’s scrupulous processes and checks may capture could be easily missed by the ordinary person.
Sellers should protect themselves by familiarizing themselves with the red flags of fraud and criminal behaviour in a VTB deal.
- Ensure that the terms of the VTB are appropriately defined in the agreement of purchase and sale prior to the closing date.
It is important to have a real estate lawyer review the VTB terms in it full. Either have this done before you sign the agreement or insert a clause that the agreement is conditional on your lawyer’s review.
Sellers should protect themselves by hiring an experienced lawyer to review the VTB agreement.
This article highlights of a few, of the many complexities of VTBs. If this is something you are considering, make sure you are fully informed of the benefits and risks. Know when to seize opportunities and how to protect yourself if you decide to take them. Get in touch with our real estate lawyers today.