What Is a Vendor Take-Back Mortgage and How Does It Work?
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A vendor take-back mortgage can help homeowners and real estate investors sell properties that aren’t moving in a tough market. They can also help buyers finance homes in a tight lending environment, or in a lending market that can’t accommodate their finances.
This type of mortgage can offer flexible solutions to challenging homebuying scenarios. However, it can also pose major risks for both buyers and sellers.
Here’s what you need to know about vendor take-back mortgages:
What is a vendor take-back mortgage?
A vendor take-back (VTB) mortgage is a loan from a property seller to a property buyer. It can cover all or part of the purchase price.
Vendor take-back mortgages aren’t a popular way for individuals to buy and sell a primary residence. More often they’re used by real estate investors.
A vendor take-back mortgage is considered a type of creative financing, or an alternative to traditional financing. Whether you’re considering this option as a buyer or seller, proceed with caution.
- Seller financing
- Seller take-back mortgage
- Seller carry-back mortgage
- Carry-back financing
- Owner financing
How vendor take-back mortgages work
A vendor take-back mortgage functions much like a traditional mortgage, only there’s no lender serving as the middleman. The seller will act as a lender and have a lien on the home, and the buyer will make monthly payments to the seller. Like a traditional mortgage, the home serves as collateral for the take-back loan.
Here’s what to expect if you’re using a vendor take-back mortgage to buy or sell a home:
- If you’re buying a home using seller financing: The seller will become your mortgage lender. They might be your only lender, or you might also finance part of the purchase price through another source, such as a bank. You’ll need to sign a promissory note legally agreeing to the deal’s terms. A buyer might consider a take-back home loan if they have poor credit, a lot of debt, or some other factor preventing them from qualifying for a mortgage.
- If you’re selling a home using seller financing: You’ll become the buyer’s mortgage lender. You’ll need to own your home free and clear before you can consider this option. Depending on the buyer’s needs, you might lend the entire purchase price or just part of it. A seller might consider this type of financing in a strong buyer’s market.
What are typical terms of a VTB mortgage?
If a vendor take-back mortgage will be the only financing, the buyer and seller have a lot of flexibility in structuring the deal.
Sellers will typically ask for a higher interest rate since they’re taking on risk by serving as the lender of the loan. But, the type of loan and length of the loan term can vary depending on the buyer’s needs.
Overall, there’s a lot of room for negotiating terms and closing costs, which is what makes vendor take-back mortgages enticing for both buyers and sellers.
Under federal law, that includes charging a fixed interest rate (or an adjustable rate that adjusts after five years) and making a good faith determination that the buyer can pay back the loan.
State law may require several pages of disclosures in a vendor financing agreement. And usury laws may cap how much interest you can charge as the seller, depending on how your state categorizes the transaction.
Be sure to hire an experienced lawyer to help you through the legal aspects of the transaction.
Benefits and risks of a vendor take-back mortgage
Whether you’re the buyer or the seller in a vendor take-back deal, you’ll want to understand the benefits and risks before signing any paperwork.
Benefits for buyers
As a buyer, you might be interested in a seller take-back mortgage because of these potential benefits:
- More financing opportunities: If you’ve shopped around extensively and can’t find a lender that’ll give you a mortgage, seller financing might allow you to fund the purchase.
- Fewer closing costs: With seller financing, you shouldn’t have to pay for an origination fee or mortgage insurance premiums. Other closing costs, like a home appraisal and title search are up to your discretion (though, they’re generally encouraged to help protect your investment).
- Customized financing terms: You’ll still have to follow state and federal laws, but you won’t have to follow rules established by entities like Fannie Mae and the Federal Housing Administration. This leaves more room for negotiating the terms of your loan, and you might wind up with more favorable terms as a result.
Risks for buyers
However, you should also be wary of some serious potential drawbacks:
- Higher interest rates: If you can’t get a traditional mortgage because lenders think your financial profile is too risky, an individual seller will likely feel the same way. If they do agree to a vendor take-back mortgage, they may charge a high interest rate to compensate them for the risk.
- Potential for mortgage fraud: A seller who doesn’t have the right (or intention) to give you a legal interest in the property might take your monthly payments under the guise of offering seller financing. You might think you’ve purchased a home when you’re really just renting it. And, if the property is already mortgaged and the borrower doesn’t pay, you could get evicted.
- Foregoing traditional protections: If you’re not experienced in buying and selling real estate, you could easily overpay for the home or buy a property with title defects that threaten your ownership rights. This is why most lenders require a home appraisal and title search.
Benefits for sellers
If you’re selling a home, here’s what might entice you to offer seller financing to a homebuyer:
- Extra income on interest: Becoming a private lender might appeal to you if the price is right as it could end up netting you a higher return than your other interest-bearing investments. Of course, you’ll still need to pay tax on the interest income.
- Better chance at closing: In a buyer’s market where you haven’t been able to sell your home, a vendor take-back mortgage might help make the transaction possible and allow you to get closer to your asking price when other buyers have made lower offers. And since you’ll avoid lender processing times and other steps in the underwriting process, you may be able to close the deal faster.
- Tax breaks: If you’re eligible, you might not owe tax on the first $250,000 in profit from selling your home; that exemption doubles if you’re married. Using a vendor take-back mortgage might also allow you to treat the sale as an installment sale and pay less tax by receiving the proceeds over several years.
Risks for sellers
As a seller, you’ll also face certain risks if you offer seller financing to homebuyers:
- Not getting all of the cash upfront: If you’re selling your home, you probably want to use the proceeds to buy a different home, increase your savings, or put toward some other expense. Providing seller financing means getting paid over time instead.
- Additional risk: If the borrower stops paying and you’re the sole lender, you may have to pursue costly and time-consuming foreclosure proceedings. If you provide secondary financing, you’re still likely to come up empty-handed since you hold the second lien. The primary lender will hold the first lien and will get paid first from foreclosing and selling the home.
- Unqualified or fraudulent buyers: There’s a good chance you don’t have the know-how or relationships to check a buyer’s creditworthiness with the thoroughness and accuracy that traditional mortgage lenders can. The buyer may not have the capacity or willingness to repay the loan.
Vendor take-back mortgage vs. traditional mortgage
There are some key differences between vendor take-back mortgages and traditional mortgages:
|VTB mortgage||Traditional mortgage|
|Lender||Home seller||Includes banks, mortgage lenders, and credit unions|
|Interest rate||Generally higher than traditional mortgage rates||Varies depending on a number of factors, including market conditions, loan size, and your credit score|
|Closing costs||Up to the two parties, but usually lower than what you would pay with a traditional lender||Typically 2% to 5% of the loan amount|
|Loan terms||Must have a fixed rate or an adjustable interest rate with no adjustment in the first five years; other terms, such as the term length, are negotiable||Varies by lender (many lenders offer fixed-rate and adjustable-rate loans with terms between 10 to 30 years)|
|Qualifications||Whatever the seller will accept, subject to state and federal laws||Varies by loan type and lender (often a credit score of at least 620, a down payment of at least 3%, and a DTI of 50% or less)|
|Mortgage insurance||None||Often required with less than 20% down|
Example of a vendor take-back mortgage
A vendor take-back mortgage can provide all or part of the financing a buyer needs. Here’s how those two options might work.
Partially funded VTB mortgage example
Let’s say you’re selling your house for $800,000, but no one has offered close to your asking price — and you’re not willing to sell for less.
A buyer’s agent suggests that you accept an offer in which the buyer makes a down payment of $50,000, gets a first mortgage for $650,000, and you finance the remaining $100,000 as a second mortgage (the VTB mortgage).
At closing, you would get $700,000 (the down payment plus the first mortgage). Over the next five years — or whatever terms you agreed to with the buyer — you would get the remaining $100,000.
Fully funded VTB mortgage example
Perhaps you’re in the market to buy a home, but can’t get pre-approved for a mortgage. But your agent convinces an investor who owns many homes to sell one to you and provide all of the financing.
The seller agrees, as long as you agree to an interest rate of 8% and pay off the loan in 10 years. The seller would hold the first and only mortgage against the home in the form of a VTB mortgage.
When to consider a vendor take-back mortgage
Vendor take-back mortgages come with significant risk for both the buyer and seller. They also require a level of financial sophistication that many individuals don’t have.
Here are the types of people who should and shouldn’t consider a vendor take-back mortgage:
- Who a VTB mortgage is best suited for: A wealthy real estate investor or someone with a higher risk tolerance and experience with real estate transactions.
- Who a VTB mortgage is not suited for: Anyone whose retirement nest egg or personal savings is largely tied up in their home equity. Same goes for anyone unfamiliar with real estate laws and transactions. If any of this applies to you, and you lack the resources to hire a real estate attorney, you should probably avoid seller financing.
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