What is a Vendor Take-back Mortgage in Canada?

An overview of what a vendor take-back mortgage is, how it works and the pros and cons of this type of loan.

A vendor take-back mortgage is a specific type of mortgage where the home’s seller extends a loan to the buyer to facilitate the property’s sale. This alternative form of financing can benefit both the buyer and the seller. For the buyer, it might enable the purchase of a property that surpasses their bank-determined financing limit. For the seller, this arrangement offers the potential benefit of getting their property sold and earning interest on the loaned amount.

How a Vendor Take-back Mortgage Works

A vendor take-back mortgage occurs when the seller of the home extends a loan to the buyer for some portion of the sales price. The seller retains equity in the home and continues to hold a percentage equivalent to the amount of the loan until it is fully repaid. This means the seller essentially has a stake in the home, which remains until the buyer fulfills the financial terms outlined.

Buyers typically secure a primary source of funding through a financial institution before opting for this type of mortgage. Therefore, a vendor take-back mortgage often represents a second lien on the property. The seller maintains ownership of a share of the home, proportional to the loan’s amount. Once the initial sum plus interest is paid, this dual ownership concludes.

The second lien also acts as a guarantee for loan repayment. Should the buyer default, the seller has the right to seize the property subject to the lien. Thus, this form of mortgage facilitates loan security for the seller.

Benefits for Buyers and Sellers

Vendor take-back mortgages present specific benefits to sellers. They provide a means for generating additional income through the interest accrued on the loan. Sellers, thus, have an opportunity to profit beyond the sale price of the home while mitigating some risks associated with having an unsold property.

For buyers, these mortgages can make it possible to acquire properties that exceed the financing limitations imposed by traditional banking institutions. By obtaining a vendor take-back mortgage, buyers can access funds that allow them to purchase homes they otherwise might not be able to afford.

Vendor Take-back Mortgage vs. Traditional Mortgage

Typically, a vendor take-back mortgage complements a traditional mortgage. In a traditional mortgage, the homebuyer uses the house as collateral for the loan from a bank. Should the buyer default, the bank has a claim on the house and can sell it to clear the outstanding debt. The same mechanism applies to the vendor take-back mortgage with the seller or second lienholder entitled to similar actions in the case of the buyer’s default.

Fixed-rate mortgages are the most common type of traditional mortgage. They ensure the borrower pays a consistent interest rate over the loan’s duration. Terms generally range from 10 to 30 years, during which interest payments remain unaffected by market rate fluctuations. Borrowers can refinance to secure lower rates if market interest rates drop after the initial loan agreement.

Several factors influence the interest rate on a traditional mortgage. These include the buyer’s credit history, down payment size, and property location. Similarly, various factors determine the interest rate on a vendor take-back mortgage. The amount the buyer asks the seller to carry impacts the rate. Second-lien vendor take-back mortgages often carry higher interest rates due to increased seller risk.

Example of a Vendor Take-back Mortgage

Consider Janet, who is purchasing her first home for $400,000. She must make a down payment of 20% or $80,000 to a fixed-rate mortgage lender. Instead of providing the full down payment herself, Janet opts for a vendor take-back mortgage arrangement. The seller provides $40,000 for the down payment and agrees to contribute $40,000 themselves.

As a result, the property now supports two distinct loans. The first is the fixed-rate mortgage of $320,000 with a financial institution. The second is an $80,000 vendor take-back mortgage. The fixed-rate mortgage uses the property as collateral, while the vendor take-back mortgage secures a lien on the same property. In default scenarios, the bank can foreclose on the home and use sale proceeds to clear unpaid debts.

Vendor Take-back Mortgage vs. Regular Mortgages

Vendor take-back mortgages differ from regular mortgages in their lending source. A vendor take-back mortgage involves borrowing from the property’s original owner instead of a traditional bank or mortgage lender. Consequently, the seller retains partial ownership of the property until the loan is paid off.

Advantages and Disadvantages

These mortgages allow buyers to purchase properties that exceed their initial affordability. Buyers benefit by accessing necessary additional funds, while sellers benefit by potentially facilitating property sales that might otherwise be prolonged.

One primary disadvantage for buyers is the typically higher interest rates compared to traditional mortgages. Because the seller assumes greater risk with a subordinate lien, they often charge increased interest rates to offset this risk. The seller may lose their investment if the buyer defaults on their first mortgage.