5 steps to positive cashflow through vendor financing

Lending criteria have continued to tighten over the last three years, with most banks now hesitant to extend funds to all but the very lowest-risk borrowers.

While this makes it difficult for some buyers to get into the property market, it also presents a unique opportunity for savvy investors to create a positive cash flow deal through vendor finance.

Vendor finance, also known as owner finance, occurs when you as the seller lend close to 100% of the sale price to the buyer, essentially acting as the bank.

You retain title of the property until the full balance is repaid, within two to three years, which usually happens when the buyer takes a conventional home loan from the bank to pay you out.

For the duration of the vendor finance agreement, the buyer will generally take a caveat over the property as security to ensure you don’t dispose of the asset during your agreement.

It can work like this…

  1. You buy a property – under market value – for example, for $200,000
  2. After finding a buyer, you agree to sell the property under vendor finance terms for $230,000, with the transaction settling in three years time
  3. The buyer pays you a $15,000 deposit (usually made up of the $7,000 First Home Owners Grant plus $8,000 savings)
  4. You use this deposit plus your own funds to pay a 10% deposit of $20,000 and obtain a principal and interest loan for $180,000 at 6.5% interest ($13,650 pa)
  5. You charge the buyer a principal and interest mortgage repayments at 7% on their $215,000 loan ($16,300 pa)
  6. The buyer is responsible for paying insurance (you of course pay and they refund you), rates and repairs (it’s going to be their house after all)
  7. Upon settlement in three years time, the buyer obtains a bank loan for the remaining $215,000 to finalise the deal

It’s a win-win for both parties. For the buyer, they have the opportunity to own their own home while working on their situation – by improving their credit profile, or saving a 10% cash deposit – while you as the vendor enjoy positive cash flow returns on your investment of $2,650 a year (of $220 per week).

So how do you make it work in the real world? Flynn De Freitas, principal of Omega Investments, offers these five steps in order to make it happen…

1. Buy below market value
Ideally, you want to buy the property at below its market value, so you can vendor finance a buyer to purchase the property at a fair market price.

2. Perform a credit check
“Vendor finance doesn’t work if you back a buyer who should not be buying a house yet,” De Freitas says. “You need to find buyers who are at the edge of the bank’s credit criteria, meaning they just missed out, but are good credit risks.” Be sure to ask for their current credit file (available via www.mycreditfile.com.au) and ask for explanations on any defaults that show up. Also, make sure you speak with their employer and ask for landlord references.

3. Get the lawyers involved
Legal advice is imperative to make sure nothing goes wrong, such as a dispute over repayments, and to ensure you comply with any relevant legislation. “For example, in Victoria you need to be a registered ‘credit provider’,” De Freitas advises. “Also, home loans are covered by the Uniform Consumer Credit Code which is a powerful piece of legislation that protects buyers from unethical lenders. You need to read this and make sure you abide by it.”

4. Calculate repayments correctly
Consider speaking to your accountant to set up a repayment schedule. Both you and the buyer need to understand the consequences of any missed repayments and/or defaults, with contract provisions that if the buyer continually fails to make repayments, you can take back possession of the home.

5. Manage your buyer
“Just like a landlord, you will need to ensure they pay their loan repayments on time and look after the property,” De Freitas says. “Usually buyers look after the property quite well – after all, it will be their own house soon. However, you still need to have regular inspections. Both you and the buyer also need to understand the consequences of any missed repayments and/or defaults on the property.”

Flynn De Freitas is a property investment analysis specialising in residential property investment in regional mining towns. Utilising his training and experience as a former management consultant and investment banker, he’s developed an extensive knowledge and understanding of towns exposed to the commodities boom.

This article provides general information only and does not constitute financial advice. Investors are advised to do their own due diligence prior to making any investment decisions based on the information provided in this article.