In 1990 banks were charging 15% for a variable-rate mortgage, while five-year home loans were 14%. The real estate market was tanking, as you might expect. The only way many people could sell their houses was to offer buyers a deal on financing.
I mention this for two reasons. First, interest rates will rise again and when they do current home prices will be crushed. Fifteen per cent loans are not in the cards, but it won’t take much to start breaking arms. Look at the serious impact F’s squishing of 30-year loans has had – and that was the equivalent of just a 0.9% rate hike.
Second, there was some discussion on this miserable blog last weekend about VTBs – vendor take-back mortgages – and how they’re a no-brainer way to sell your house, suck cash flow from the borrower, and take virtually no risk. One poster posed this question: “We are selling our home in Richmond Hill. What are the potential benefits and concerns of holding the mortgage?”
That elicited this response from another: “Private lenders are lending to those the banks reject lending to every day and for far better returns than anything Garth has ever suggested here. If the buyer is willing to put x amount of dollars of his own money into the purchase – anywhere from 5 to 10 percent of the purchase price and you can get him to go a 1st mortgage on 70% (with you) and let them find a broker who can arrange a second for the difference, then you move out with 30% of the purchase price in cash in your pocket while holding a 1st mortgage doable at 8.5 -9% – You will be way ahead in the game with a grand monthly income being generated from your Richmond Hill property. More than enough income there to rent a place with for yourself – and with a load of cash to boot with your bulk principle secure.”
So, let’s throw a little light on this subject. A VTB means the seller becomes a lender. Instead of pocketing the sale price of the home, you might receive only the down payment and forgo the principal in return for amortized monthly payments. Yup, just like a bank. But unlike a bank, you can’t get CMHC insurance on a high-ratio VTB (for 80% of more of the sale price), so if the buyer walks, you’re likely screwed (more on this in a moment).
A VTB is a legal obligation, so it has to be properly executed by a lawyer and registered against the deed. This costs money. You also want to ensure the buyer gives you not only a signature on the document, but a personal guarantee. It might also be wise to ask for a child as security.
On first blush, this may look like a good deal. Sell the house. Get 20% in cash. Take back a mortgage and enjoy a monthly payment with a fat interest rate. Get the property back if the dude walks. If you have a house with no mortgage, isn’t this a way of turning it into a cash-flow machine?
Not so fast. Like loaning money to ‘mortgage syndicates’ or ‘mortgage pools’ – both popular these days among people hungry for yield – this is a great way of making money disappear in a real estate correction. There’s a reason VTBs have typically been an instrument of despair – accepted by sellers who absolutely have to get out, and can’t get a buyer any other way. So, taking back a first mortgage is a rare thing. Normally a seller will assist only with the financing gap between what a buyer might have arranged from the bank and what they have as a down payment. That might be 5% or maybe 10% of the sale price, and still there’s huge risk involved, since in the case of non-payment you have no real security.
Does that mean letting someone buy your home with a deposit only, and you holding a mortgage secured against the property, is relatively riskless?
Hardly. First, if you can digest or breathe you can still get a mortgage in Canada, and at prime or less if it’s a variable-rate loan. That suggests anyone incapable of being bank-approved is homeless for a reason, like they have no money, a hideous credit history, or served time for grand larceny. Do you really want a relationship?
Second, if they stop paying it doesn’t mean you change the locks and move back in, keeping the down payment. Legally it’s not your house any more. You don’t own the deed. And the only way of getting it back is to begin power of sale proceedings (or, in some provinces, foreclosure). This means you need a lawyer (who needs a retainer), courts, and time. The guy you ‘sold’ to continues to live in the house, and by making a payment at any time during the long process, can set the legal clock back to zero.
Finally, why would any purchaser agree to pay 9% for a mortgage on your house, or about three times the going rate, if they actually intended on making payments for the entire three- or five-year term? Would you? What if they borrowed the down payment as well as your VTB, intend to live there for a year of non-payments, then depart? Under power-of-sale rules the property has to go on the open market and find a buyer at market prices. If you take less, the dude you sold to – who didn’t pay – can sue you.
Now imagine if we had a real estate correction (which we will), and the property declines to be worth less than the financing you hold. You have no house, no cash flow and (probably) no buyer. Oh yeah, and legal bills.
The moral? Never take advice from a stupid blog.