Sunday, April 06, 2014

Why Helping With Financing Is A Benefit For The Seller

Have you ever had a property for sale, but there were no buyers? Or you had a buyer with a desirable offer in place but the financing fell through? Or your real estate agent as been recommending you lower your price again and again, so that after paying your realtors fees you are left with very little from the equity of your property?

It can be very disappointing to have been working so hard paying down the mortgage on your property to build up the equity just to see it disappear in the details of the sale. There are different ways to maximize the amount that goes in your pocket from the sale of your house. Today I will be concentrating on assisting with the financing.

For a first time home buyer, they should be able to purchase a property with a deposit of 5%. So for a $300,000 home that would be $15,000. That's not so bad. It gets a little harder to obtain when you think that a big majority of first time buyers first attended college or university. They might have been concentrating on paying down student loans instead of saving for a down payment. 

Not only that, but banks and CMHC have been changing their rules surrounding mortgages, making obtaining a mortgage a little harder and sometimes needing a larger down payment. In fact, CMHC as just increased their rate to insure a home mortgage by about 15%. It might be easier to obtain a mortgage without going through the regulation of a CMHC mortgage. But in order to do so the down payment would now need to be 20%. For that $300,000 house that is now $60,000. On top of paying off student loans.

For commercial mortgages, the necessary down payment is 35%. On a $300,000 purchase price that would be $105,000. Down payments are so high in commercial mortgage that assisting in financing is very common. The most common form of assisting is with a VTB (Vendor Take Back mortgage). There would still be a regular first position mortgage with the traditional lender (Bank). Then the seller would hold a second position mortgage against the equity of the property.

On that $300,000 example, lets assume the bank is holding 65% on a first position mortgage ($195,000) and that the seller is agreeing to holding a VTB for 20% of the property value ($60,000) this would leave the buyer with the responsibility of supplying a down payment of 15% ($45,000). This would make the whole transaction much more feasible for the buyer since he now as to come up with only $45,000 for the down payment instead of $105,000.

Now, lets discuss what is in it for the seller. First, he is getting the property sold when the large deposit of this deal might have scared potential buyers away. However he is not getting the full asking price up front. In fact in this example he would receive $240,000 at closing. But he did not have to lower the price. The remaining $60,000 is still due to him in the form of a mortgage. And not only that but it is secured against the property he just sold. The terms of the mortgage was determined between the buyer and the seller during the negotiation of the sell. 

I have in the past, posted about the types of rates you can expect for holding a second position mortgage. You can review that here. Based on that information, lets assume the seller and buyer in our example agreed to an interest rate of 10% and for a term of 5 years. For simplicity sake lets also assume that they agreed to make the payments interest only. (As a investor buyer, I prefer interest only as it gives me a smaller monthly payment therefore improving my monthly cashflow. As a seller, it gives me more money in the long run.) In this example the seller would be receiving a monthly payment of $500 ($60,000 x 10% which is then divided by 12 months). So after the 5 year term, the seller would have collected $30,000 in payments on top of being paid back for the $60,000 VTB. By offering a VTB, in this example, not only was the seller able to facilitate the sale and get his asking price; he also collected an additional $30,000.

Sometimes, there is not enough available equity to offer a traditional VTB, mostly if there are realtor fees involve. This is where Arm's Length Mortgages could be used instead.

Within your registered account, such as an RRSP; you can hold stock and mutual funds. But did you know you could also hold a mortgage? These are called Arm's Length Mortgages. They can only be used on property you, or a close relative do not own. Hence the term Arm's Length Mortgage. Just like the VTB the terms of the Arm's Length Mortgage would be negotiated between the buyer and RRSP owner. As an RRSP owner you could offer to hold an Arm's Length Mortgage on any properties (not mobile homes) that the buyer is purchasing or is owning. But you could also offer that service on the property you are selling if there was no equity for a VTB of if you are in need of that equity right away.

Here is how this would take place. You sell you property for $300,000. The bank is providing a 1st position mortgage of $195,000. The buyer as a deposit of $45,000. You would have $60,000 of your RRSP moved to a self manage RRSP which would then be transferred to a Trustee (such as Olympia Trust) that would facilitate the mortgage. The trustee would then create the mortgage which is registered against the property and at closing a cheque would be issued and sent to you. At closing you would receive, $195,000 from the bank mortgage, $60,000 from the Arm's Length Mortgage as well as the $45,000 deposit from the buyer. For a total of $300,000. So even though you are helping with financing you will be collecting in cash the full asking price.

Going forward regular payments would be deposited in the trust account (back into your RRSP). At the end of the term, the seller would refinance the property and pay off the Arm's Length Mortgage which would return all the remaining principal and interest due back to your RRSP. Take note, the RRSP money was only ever transferred within the registered account and therefore never created a taxable event. Also the interest made on the mortgage was also within the RRSP and is as such under the same protection had it been made in the stock market. But I think we will all agree that the RRSP secured to the property is much more secure then an RRSP holding stocks or mutual funds at the mercy of a volatile market.

One of the disadvantage of holding an Arm's Length Mortgage is that the additional money made from holding the mortgage ($30,000) is held within the RRSP account and technically should only be used at your retirement. But seeing as this is extra money that you would not have made with a traditional sale; I think the trade off is fair.