Vendor finance or rent to own finance isn’t for everyone. There are a few risks and higher costs involved so you should probably consider these other no deposit home loan options before going down this path.
Vendor finance is the term used for a range of methods to buy a home without using a standard bank loan.
Typically, it involves the seller (vendor) or a private investor helping you with either a rent-to-own, instalment contract (wrap) or by financing your deposit.
What is vendor finance?
There are actually three different types of vendor finance.
Standard vendor finance / instalment plan
This is also known as a “wrap”. In this scenario, you’ll work with a private investor to help you buy a home. When you find a home that you’d like to buy, the investor will negotiate to try to buy that house for less than the market value. The investor buys the home in their name and then sells it to you at a higher price with an extended settlement.
Instead of paying the investor in one lump sum in six weeks time, you pay the investor in instalments over several years until you’re able to qualify for a loan with a bank and refinance the investor out. This is the most common type of vendor finance purchase in Australia.
Rent to own / rent to buy
This is where you have an agreement with the investor to rent the home from him at higher than the normal market rent. In return, you have an option to buy the property at a later date for a set price. This is ideal for people who’ll qualify for a bank loan in a few years time and would like to “lock in” their dream home now.
In this scenario, you’ll borrow 80% of the property value from a bank as this is easier to qualify for than a 95% home loan. The remainder will be lent to you by the vendor (seller). You make payments to the bank and also to the vendor with the aim to refinance the vendor’s loan to a standard bank loan within two to five years.
If you go for this option then you must be committed to making large repayments to repay the vendor’s loan as quickly as possible.
What are the risks of vendor finance?
Most of the risks of vendor finance revolve around your ability to afford the mortgage repayments. Vendor finance is a lot more expensive than a standard home loan and here’s why:
- You’ll pay more to buy a property: You’ll have to pay 10-20% more than what the investor paid for the property.
- Interest rates are higher: In some cases, the rates are at a 1-4% higher margin than the interest rate the investor paid their bank. So if current interest rates are around 5.00%, expect to pay 6.00% to 9.00% per annum.
- The vendor holds the cards in negotiations: The cost of the purchase and your interest rate will depend on how high of a risk you are to the investor and how quickly you can refinance out of the vendor finance scheme.
Who is vendor finance for?
If you can qualify with a major lender then it’s better that you apply for a standard mortgage.
We strongly recommend that you consider a no deposit solution like a guarantor loan as a first option because they’re significantly cheaper and a much more straightforward loan process than apply for vendor finance.
The people that often apply for vendor finance often:
- Don’t have genuine savings: Did you know that you may actually be able to borrow up to 90% or even 95% of the purchase price with a lender that doesn’t require you to have genuine savings?
- Are self employed and only have limited income evidence or financials: There are certain lenders that can accept alternative income evidence so you can still get a home loan!
- Have a bad credit history (a larger deposit is required): Depending on the size of defaults and the overall nature of your credit history, there may be lenders who will allow you to borrow up to 95% of the purchase price.
- Have no credit history: Learn more about what a credit file is and how you can start building a credit history in order to apply for a home loan. It could simply mean opening a small credit card account and paying it off over a period of 6 months rather than applying for vendor finance today.
- Don’t meet standard bank lending criteria: If your employment situation is out of the ordinary, you have problems with your credit history or there is something else stopping you from qualifying with a bank then a specialist lender may be able to help. Alternatively, a specialist mortgage broker with exceptional credit expertise and lender relationships may be able to build a strong enough case to get you approved for a standard home loan.
Yes, vendor finance is an option for you if you have no deposit but, as you can see, there may be other ways to get you approved for a mortgage.
What are the requirements?
Not everyone will qualify for vendor finance. The main qualifying criteria are:
- You must have at least 2% of the purchase price as a deposit,
- You must be able to afford the loan,
- It’s preferred that you’re buying a house or units in a major city or regional area.
Overall your situation must ‘make sense’. If you clearly can’t afford the repayments or you don’t have a good explanation for your poor credit history, then you’re not yet ready to buy a home.
How much can you afford?
There are two methods that can be used to work out how much you can afford to buy a home for. Firstly, it’s best to work out how much you can afford to repay each month. Then, work backwards to work out the amount you can afford to borrow.
The second method is to use a borrowing power calculator (serviceability calculator). We recommend that you use the same calculators used by the banks to assess someone’s ability to repay a mortgage. These are usually more accurate than generic online calculators.
When can I refinance back to a bank?
There are no hard and fast rules as to when you can refinance to a standard bank loan. However, you must have a clear credit history, stable employment and an excellent history of paying the vendor finance instalments on time and in full.
You must owe less than 80% of the property value to be able to refinance to a conventional lender with a high chance of success. If you owe 80% to 90% of the property value then you may be able to refinance but you’ll need to meet more stringent lending criteria and will require LMI approval.
If you still don’t meet the criteria of conventional lenders, then you can apply for a loan with a non-conforming or specialist lender. Although this is usually cheaper than vendor finance, it’s still more expensive than a mortgage from a bank.
Don’t rely only on your property rising in value to help you get down to owing 80% of the property value. You should commit to making large additional repayments to reduce your debt. Please keep in mind that bank valuers are conservative so it may take a little longer than you predict to reduce your debt enough to refinance.
How much does it cost?
The terms of the vendor finance agreement will be negotiated between you and the investor directly. There are no hard and fast rules.
If you’re able to refinance quickly then the investor may be able to offer you more favourable terms.
Do I need legal advice?
Although vendor finance is a very powerful method that can be used to help you own your own home, it can be a disaster if you don’t understand the terms of the agreement. Please seek independent legal advice prior to entering into an instalment plan, rent to own or financed deposit scheme as they’re legally binding contracts.
We’ve taken great care to ensure that the general information on this page is accurate, however vendor finance agreements are negotiated between you and a private investor so each agreement will vary.
The terms of your finance are likely to be at least slightly different to what we’ve written above so please take the time to understand your agreement fully before deciding if it’s for you.
You must also be aware that if you miss several payments with a vendor finance instalment plan or rent to buy scheme, you may lose the deposit you’ve paid and the right to purchase the property.
Private investors don’t often have the financial means to hold onto a property if you’re not making your repayments. For this reason, they’ll be less lenient with you than a bank would if you missed payments on a mortgage.