Vendor Financiers have for years been proud of the flexibility offered when selling vendor financed residential property to home buyers. Considering the general level of financial literacy in the community, is this quiet assurance that we’re doing the right thing, misplaced?
It’s been an interesting insight helping Karen in Vendor Finance Management for all these years. It’s cemented in my mind the importance of consumer protection in the area of finance.
Like Robert Kiyosaki’s comments about financial literacy in the USA, we continue to be amazed at the lack of financial literacy within the Australian community. Someone once said to me, tongue in cheek, that all Australian consumers want to know is, “how much deposit and how much per week?” Obviously this is a gross generalisation but, in our experience, often it’s not. And when you’re talking about a home buying transaction, involving hundreds of thousands of dollars, you can see why governments put consumer protection rules in place.
Two Areas of Reduced Protection
The traditional home loan industry has taken these rules, i.e. the National Credit Code (NCC), very seriously. The Vendor Finance home lending industry, less so. The two glaring areas of reduced consumer protection, when a consumer uses vendor finance to buy a residential property are:
- Rent To Buys do not give the consumer-buyer the protection of the NCC, and;
- Traditional consumer home lending practices do not generally have short terms that require ‘balloon payments’.
Rent To Buys
Rent To Buys (RTB’s) are documented by a Residential Lease and a Call Option. The combination of these two legal documents does not currently meet the definition of a consumer ‘credit contract’ and is therefore not regulated by the NCC. This means consumer tenant/buyers cannot rely on the protections of the NCC when they use a RTB to buy their home. As a result, the Vendor (Seller) does not have to provide the tenant/buyer with, e.g. compliance with the NCC’s Responsible Lending requirements or provide appropriate Hardship procedures if they’re experiencing financial difficulties.
Traditional home lenders structure their loans so the buyer’s loan balance is calculated to be zero at the end of the term of the loan. Vendor Financiers often structure their vendor finance arrangements with shorter terms, e.g. 5 years, requiring a large final payment (normally called a ‘balloon payment’). ASIC clearly finds these short terms and associated balloon payments unfair in the consumer lending marketplace, even if one or two year extensions are provided in the legal paperwork. The following is an extract from ASIC’s Regulatory Guide 209.68
“Example 10: Balloon repayments
Some products involve a large ‘balloon’ payment at the end of the loan term. While a consumer may be able to manage the regular repayments under the loan, whether the product is suitable for them also depends on whether they will be able to make the final, much larger, payment. We would expect the credit licensee to satisfy themselves that the consumer understands, and has the capacity to cover, the final repayment before offering this type of product to the consumer. “
Tips for Vendor Finance Buyers
These two big differences between traditional home lending and vendor finance home lending have led us to add the following tips to the information we supply to all our prospective vendor finance buyers:
- Make sure the term length of the Vendor Finance (VF) arrangement is around 20 to 30 years, i.e. make sure the arrangement results in your loan balance being zero at the end of the term. Do not get talked into a shorter term arrangement, as you can never guarantee when you will qualify for a traditional home loan;
- Insist that the legal paperwork used for the VF arrangement is an Instalment (Terms) Contract, not a Lease/Option (usually called a Rent To Buy). This is because when using an Instalment Contract, you are protected by the National Credit Code and when a Rent To Buy is used, you’re not protected by the National Credit Code;
- We do not charge any exit fees, other than what we’re required to pay the bank to payout our loan on the property;
- We suggest you only deal with a seller’s representative that has both an Australian Credit Licence (or is an authorised Representative of an ACL holder) and an Real Estate Agent Licence (or is an authorised Rep);
- If you are dealing directly with the Owner, as the seller, use the above information to negotiate the vendor finance arrangement;
- In either case:
- (a) make sure you use an experienced Vendor Finance lawyer to represent you and fully check the legal paperwork, and
- (b) insist the seller uses an experienced Vendor Finance lawyer to draw up the legal paperwork.
Client First – Always.