Vendor Take Back Mortgages

A vendor take back (VTB) mortgage is when the seller (also called the vendor) grants the buyer a mortgage for the equity they own in the property, in lieu of a cash buyout (what typically happens). A VTB can also function as part of a real estate sales agreement, where the seller pays for some of the closing costs, like the land transfer tax, appraisal fees, property inspection etc.

VTB’s are much more common in the commercial real estate sector. However, they are perfectly legal for all Canadian residential real estate as well. Any real estate owner can give another person(s) or business a VTB mortgage so long as they have equity in the property in question. A VTB can be one of the best ways to manage your capital gains tax owed. Vendor take back mortgages are also one of the best ways to convert an investors time intensive and comparatively more risky real estate portfolio into a steady stream of monthly cash flow from secure private mortgages.

Advantages for Sellers

• A VTB allows sellers to convert the equity in their property into a reliable stream of monthly income. The monthly cash flow could be much higher than the property previously generated in rent. Many people sell their properties because they wish to free up cash for investing/retirement anyways. A VTB can be a way to kill 2 birds with one stone by exchanging the property for a steady stream of mortgage repayments with the loan secured on title. This can be a very powerful technique for long term wealth creation.
• A VTB lets sellers reduce the overall amount of capital gains tax they will pay. It also gives sellers the ability to spread their newfound taxable income over multiple years. This gives them more flexibility to manage which tax bracket they fall into.
• Expands the pool of potential buyers for your property.
• Many investors will pay a premium price for a property if they have the option to avoid dealing with a third-party lender. Especially if their alternative is to obtain an expensive loan from a hard money lender.

Advantages for Buyers

• You can purchase a property with a less than stellar credit score. Some people with poor credit are actually reliable, excellent lending prospects. However, their credit may be temporarily damaged by an unforeseen events like a divorce or failed business venture.
• It’s possible to negotiate very favourable mortgage contract terms
• It’s possible to purchase with a very small (or even 0%) down payment.

Advantages for Investors

• A viable way to expand your portfolio without paying mortgage origination fees to private/hard money lenders.
• Often VTB’s have lower interest rates than those charged by private money lenders.
• It’s possible to use this strategy to purchase a new income property with a down payment of less than 20%. Potentially even 0% down if the seller owns the property outright and is willing to offer a 100% loan to value ratio.
• A VTB can structured as a second or third mortgage. This can allow an investor to 100% finance a property and/or to pull equity out of a property to fund renovations or even the purchase of an additional property. This strategy can be used to “snowball” equity from property to property, in order to quickly grow a portfolio. Great caution should be exercised though, as the investor is taking on additional debt with each new VTB. Because the debt is secured on title it is generally considered much less risky than a conventional private loan.When properly applied vendor take back mortgages can be a great way to create wealth and grow your net worth.

When is a Vendor Take Back Mortgage a Bad Idea?

• Anytime the VTB contract has not been drafted or at least thoroughly reviewed by an experienced real estate lawyer. A best practice is to get the agreement reviewed by a mortgage broker as well, to confirm that the payment amount, frequency, and amortization have been correctly calculated. VTB agreements are complicated and legally binding. They should always be drafted by a lawyer working in tandem with a professional real estate consultant and/or mortgage broker.
• Anytime the buyer/borrower can’t show a clear plan/capability to make the mortgage payments consistently and on time. The potential buyer should be able to explain how exactly they will be able to afford the payments and how large their reserve fund is. It’s a giant red flag if they can’t do this.
• If the VTB has to take a third or fourth position to other mortgage loans from other lenders than the sellers’ odds of ever recouping their losses in the event of default is extremely low.
• On a related note. If the VTB creates a situation where the buyer will exceed a 100% loan to value ratio on the property then it will likely also be impossible for you to recover 100% of the money owed to you if the buyer stops making the mortgage payments. In other words, never give a mortgage for more than a properties total value! It can be tempting to do so and some less than scrupulous or incompetent investors will pitch this type of arrangement to sellers. Often because they have a flawed or dishonest business model, and this is the only way they can afford to “buy” new properties. Taking them up on that offer is almost always a terrible idea.
• If the buyer/borrower is dependent on a growing real estate market to make the payments or pay out the mortgage. Lending to an inexperienced house flipper or rental investor with no plan to positively cash flow.

For more information on the other types of mortgages available to Canadian investors check out my post about other mortgage types.