To help achieve a sale in particular market conditions vendor finance can be a useful option.
Vendor finance is when the seller ‘leaves some money in’ the property for an agreed period to assist the buyer to complete the purchase.
Certain market conditions make vendor finance useful for both parties. Our current rural property market has those conditions: high interest rates, tight credit, and more farms listed for sale than buyers motivated to purchase. Understanding these dynamics will help buyers and sellers determine whether this financing method is the right one for their particular transaction.
Tight credit markets, when traditional financial institutions adhere to stricter lending criteria or when higher interest rates make conventional bank loans less attractive, can make vendor finance a viable option. Vendor financing can either provide an alternative source of finance for buyers who cannot secure a traditional loan or augment an existing bank loan which may be restricted for loan-to-value ratios.
When the party selling the farm puts up finance, that offer may come with more flexible terms to better accommodate the buyer’s situation, therefore potentially attracting a larger pool of buyers, including those with less-than-perfect credit or irregular income.
In a buyer’s market, where a high inventory of properties will likely lead to increased competition among sellers, properties generally remain on the market for longer, particularly in the rural sector. Vendor finance simplifies the transaction process, differentiating the property, increasing its appeal by bringing it within easier reach of the buyer, and can speed up the sale process by providing a unique selling point.
Purchasers benefit from the flexible terms that a vendor can offer when they provide finance. Terms need to be negotiated directly between buyer and seller, allowing for creative solutions that meet both parties’ needs. This can include reduced initial payments and customised repayment schedules, while giving greater leeway over the qualification criteria that a buyer would need to meet at the bank.
Although it has benefits, vendor finance is not without risk, which both parties need to be aware of.
For the vendor, the primary risk is that the buyer might default on loan payments. If this occurs, the vendor may need to initiate foreclosure to reclaim the farm, which would be time-consuming, stressful and expensive. Associated with that, if the property depreciates between the sale and the default, it may be worth less than the outstanding loan balance, resulting in financial loss for the vendor.
In addition, if interest rates increase, the vendor will miss out on higher returns that would have been available through alternative investments.
Risks for the purchaser include that vendor financing generally comes with higher interest rates than a traditional mortgage, and a shorter loan term, which increases the pressure on the borrower. Vendor financing agreements might typically require the main repayment at the end of the loan term, raising the financial stress on the buyer. Either way, they will probably pay more over the life of the loan than they would with conventional financing. Buyers may also have fewer legal protections than those offered by traditional lenders, in which case any dispute with the vendor could be more challenging and costly to resolve.
An unprincipled seller might offer financing on a farm with undisclosed issues or an inflated value.
To guard against all these risks, both buyers and sellers need to take particular steps to avoid entering into a deal that goes wrong. Accessing legal, accounting and banking advice is strongly recommended.
For the vendor, that needs to include a thorough credit check and due diligence on the buyer, a substantial down payment (deposit) to reduce the risk of default, a robust legal agreement to address all possible eventualities, and regular monitoring of the buyer’s adherence to the loan terms and farm maintenance.
Meanwhile, the purchaser also needs to undertake extensive due diligence on both the farm and the seller, engage their own professional advice to construct or vet the financing agreement, ensure all its terms are clearly defined and understood, and plan for would-be refinancing options in the event they are necessary when the term of the loan agreement expires.
Under market conditions where traditional financing is less accessible, vendor finance in a rural property transaction can present a win-win for the parties. Vendors benefit from a larger pool of prospective buyers, a quicker sale, and the possibility of a higher selling price, plus the potential for ongoing income, while purchasers gain easier access to financing, reduced barriers to farm ownership, flexible terms, decreased costs, and a swifter result.
What Our Experts Have to Say:
“In my experience, whether vendor finance is going to work depends on the property.
"If you are a retiring farmer, what will you do with your money? If you are otherwise going to put it on a term deposit, and are willing to leave some of the value with the purchaser as a mortgage, that can be a win-win.
“It’s a big conversation, normally highlighted early on, and often comes up when we are listing.
The incentive is with the vendor. If doing this will achieve the sale, if they are comfortable, the interest rate is normally better than what they will get on term deposit at the bank, so a better return on their money, and leaving money in may be the best way to secure the sale.”
John Duder, Northland Sales Manager, PGG Wrightson Real Estate
“As banks tighten their books on lending, vendor finance is re-emerging.
"This can become a logical discussion with a vendor. Particularly mature vendors who understand vendor finance, having experienced it in the past.
“Where it’s a feasible option, it’s imperative that the vendor is comfortable with the purchaser’s ability to meet their obligations. As a second mortgage, that may require juggling with the bank.
“The key is the quality of purchaser, as they need to be reliable. Each party needs to do due diligence all round and everybody must have faith that they can perform under the circumstances. There is a measure of risk that the vendor must accept.
“As a salesperson, you don’t want to put your vendor in a difficult position, so some direct questions need to be asked for the purchaser to prove they are worth backing.
“Usually, a vendor finance agreement is short term, maybe two to five years, with the onus on the purchaser to clear the debt quickly. There’s every chance the banking cycle will have moved along in that period, by which time the banks may be more receptive to taking on extra debt.”
Martin Lee, Cambridge based Rural Real Estate Consultant with PGG Wrightson Real Estate
“Some older farmers will offer vendor finance, particularly for a young person that they take a shine to.
"For a young buyer trying to make the most of limited equity, when the bank needs 70 per cent, that’s a big challenge, which is where vendor finance can end up as a small percentage of a larger deal.
“Security of money is paramount and if the vendor can hold the first mortgage it is rock solid, though those are unusual. Second mortgage security must be the bare minimum.
“The terms can be flexible, though there should be an additional premium above what the market would pay. If the bank offers five or six per cent on term deposit, then you should aim to be half a point or one per cent behind that for vendor finance, giving the discount for servicing. What percentage you are prepared to leave in is key as well.
“Would you leave money in for zero per cent, which some people were doing last time vendor finance was happening? We are not at the point now.”
Paul Harper, Lower North Island Real Estate Manager, PGG Wrightson Real Estate
“Vendor finance has lain dormant for the last 20 years, though with money no longer so cheap and banks more stringent on lending criteria, it has come back into recent discussions.
“If a vendor doesn’t intend to buy another farm, they may leave some money in the property to help ensure a deal goes through. It provides another selling option, though you need to be wary, and thoroughly check out the other party.
“While you might have to agree on an interest rate less than the bank would pay, it gives the ability to get on with your life. Vendor finance is best secured with a first mortgage, which has no risk. If it’s a second mortgage, it’s a bigger risk and you’ll need more information about their credit history.
“Most important, setting up vendor finance needs good legal advice, along with an accountant or financial advisor.”
Peter Crean, Canterbury/West Coast Real Estate Manager, PGG Wrightson Real Estate
“When a farm changes hands, while vendor finance can benefit both parties, it is not the goose that laid the golden egg and requires your professional advisors, and importantly your bank, to be involved.
“If everything else lines up, vendor finance can help secure a deal. However, if you are also borrowing from the bank to make that happen, they would normally negotiate to take the first mortgage, so need to be in the conversation.
“For security, when a bank lends you money, they set a priority sum, which is typically 20 per cent more than they have loaned you. If you default, the borrower holding the first mortgage must be paid what they are owed, before you pay back your other creditors, including any vendor finance.
“In other words, vendor finance can be complicated and needs to be understood by all parties involved.
“Talking to other farmers and professionals who have experience with vendor finance is worth doing to understand it better.”
Brent Irving, Otago based Rural Real Estate Consultant with PGG Wrightson Real Estate
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