In a slow market, sellers may dangle a vendor take-back mortgage as an incentive to attract a buyer.Eduardo Lima/The Globe and Mail
In the volatile Toronto-area real estate market, parties on both sides of a sale are often searching for innovative ways to cement a deal.
One retro strategy making a comeback is the vendor take-back mortgage (VTBs). The solution was popular in the late 1980s and early 1990s when interest rates soared – and saw a brief revival in 2018 when the market dipped.
Real estate lawyer John Zinati of Zinati Kay Barristers and Solicitors sees VTBs popping up as a creative solution proposed by real estate agents trying to prevent a deal from falling apart.
Essentially the seller of a property takes on the role of a bank and lends a chunk of money to the buyer to complete the sale.
The practice is seeing a reincarnation in today’s market as higher interest rates and more conservative lenders make it harder for buyers to arrange financing. In a slow market, sellers may dangle a VTB as an incentive to attract a buyer.
Perhaps a buyer has the budget to pay $1.8-million for a house, for example, but the seller is holding firm at $2-million. An agent might suggest a vendor take-back mortgage for the additional $200,000.
See how rising interest rates will affect the cost of your mortgage
How does the Bank of Canada’s interest rate hike affect variable rate mortgages?
In another situation, a buyer may have agreed to pay $1-million for a house, but just before closing the bank’s appraisal came in at $950,000. The buyer scrambling to cover the shortfall might ask the seller for a VTB for $50,000.
“It’s a way of saving the deal, perhaps,” Mr. Zinati says. “It’s basically an IOU secured by a mortgage.”
Andre Kutyan, broker with Harvey Kalles Real Estate, points to a house for sale with an asking price in the $6-million range in north Toronto, with “interest-free mortgage available” leading off the remarks for prospective buyers.
The odd twist, says Mr. Kutyan, is that the sellers are trying to sell the house at a higher price than they paid for it in March.
“They are hoping to sell it for more when in reality it’s worth 10-per-cent less,” Mr. Kutyan says of the drop in value from the market’s peak.
Mr. Kutyan believes the gambit of offering a loan at 0 per cent interest is unlikely to entice a buyer to pay the full asking price.
He points out that the amount the buyer pays for a house is going to matter more in the long run than the interest rate on a loan for a fixed term. It’s difficult to predict how long it will be before prices begin to climb again.
“They’re not going to overpay for a house just to get free money for a short time. That party’s going to end. We could be in this for the long haul.”
A little farther north, Mr. Kutyan took a client to view a property on the market under power of sale.
The first lender in line is offering a vendor take-back mortgage in order to facilitate a deal, Mr. Kutyan says.
Builders purchased side-by-side properties in 2017 and 2018, he says, then went through the lengthy planning and approval process in preparation for building a row of townhouses.
Today the original buildings are boarded up and construction has yet to begin.
“It sounds like they lost their shirts and they don’t have a shovel in the ground.”
The owners tried to sell the combined property for about $9-million in 2020. More recently, the court-appointed receiver had taken over and the asking price had dropped to below $8-million before the listing expired.
The first mortgagee provided $6.2-million in financing to the owners but the project is worth less than $6-million, in Mr. Kutyan’s opinion.
“I don’t know if they’re going to get their equity out of the property. They’re hoping to save their skin.”
The lenders who provided second and third mortgages are unlikely to recover any funds, he adds.
On one detached house Mr. Kutyan listed for sale in North York with an asking price around the $6-million mark, a buyer submitted an offer but the two sides could not agree on price. The seller raised the idea of offering a VTB.
In the end, the seller provided a VTB at 3 per cent interest for three years and the house sold after 19 days on the market. It’s the only mortgage on the property so the risk to the seller is lower, Mr. Kutyan says.
“That was what clinched the deal.”
A vendor take-back mortgage does not always involve such high stakes. Sometimes a buyer seeks a relatively small amount to top up a first mortgage.
The catch in many scenarios, says Mr. Zinati, is that the provider of the first mortgage often has a clause in the fine print barring a second mortgage.
The ratio of the mortgage and the quality of the borrower are two factors that go into the lender’s decision, he explains.
If a buyer is borrowing 50 or 60 per cent of the value of the property, for example, the bank is more likely to allow a second mortgage. But if the buyer is borrowing 80 per cent of the property’s value, a second mortgage almost certainly won’t be allowed, Mr. Zinati says.
“The bank has an obligation to look at the totality of the debt of the borrower,” he says.
Another wrinkle is that a lawyer acting for a buyer in a deal is also acting for the financial institution that provides the first mortgage. If the buyer tries to add a second mortgage, the lawyer has an obligation to inform the primary lender.
A buyer who tries to deceive the first lender may be accused of mortgage fraud.
When he’s representing the seller, Mr. Zinati steers most clients away from agreeing to a VTB because of the risks.
“On the face of it, the answer is no – don’t do it,” Mr. Zinati advises.
If the buyer stops repaying the money, he stresses, the seller may need to take steps to collect, including using the power of sale provisions set out in the agreement.
Along the way, there would likely be pleas from the buyer to allow more time, he says, with lots of excuses and explanations for the seller to contend with.
“Most people don’t like the idea of being in this position but they must understand that this is what happens if the buyer doesn’t pay the mortgage,” he says.
Mr. Zinati adds that the seller who agrees to a VTB is second in line for repayment if another lender provided the first mortgage. If one of the lenders forces a sale and the property’s value has dropped sharply, the vendor may receive nothing after the first mortgagee gets their share.
Also, buyers who have defaulted on their second mortgage tend to be behind on lots of other payments as well. Arrears on the first mortgage, penalties for breaking the mortgage, taxes and legal fees will typically be tallied before the vendor receives a share.
But he adds that there are times when a seller will weigh those risks and decide to take a chance.
One of Mr. Zinati’s relatives asked for his advice recently when he sold his property and the buyer needed an additional $25,000.
Mr. Zinati recommended that he agree to a VTB only if he was okay with the risk of losing that amount. If the sale fell through and the family member had to put the property back on the market, he might end up selling for less the second time.
“Maybe losing this deal is worse than taking that risk,” Mr. Zinati says of the calculation sellers need to make.
Samantha Brookes, chief executive of Mortgages of Canada, says buyers also need to be aware of the hazards of a VTB.
In some cases, she says, buyers want to apply for a pre-approved mortgage from one of Canada’s big banks, but they don’t have enough cash for a down payment.
The buyer might suggest asking the seller for a VTB for a portion of the down payment. Not only is it not allowed by the primary lender, she says, the buyer needs to show proof to the mortgage broker or lender that they have funds available for the down payment.
Ms. Brookes warns that buyers might be loading on too much debt if they don’t have a substantial down payment and look for ways to skirt the rules instead.
The average buyer shouldn’t be trying to arrange a vendor take back mortgage, she cautions, because they likely don’t have the expertise to crunch the numbers or understand what they’re signing up for.
“They can be very pricey,” she says. “People are finding all kinds of creative solutions but you have to make sure you can afford it.”