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Instalment Sales

Often called Terms Sales, Instalment Sales are vendor finance sales where the vendor (the owner) finances the purchaser, instead of a bank financing the purchaser. The purchaser pays a small deposit, moves in, and pays the price instalments until they are ready to refinance or sell.
 

Basic Structure

The Instalment Sale form of vendor finance is structured to offer homebuyers a home purchase contract with a built-in opportunity to build up sufficient equity (a deposit) and a good track record of payments (creditworthiness) to qualify for bank finance at a future time.

The vendor has two tasks, which they delegate. The first is the preparation of a Terms Contract, which is delegated to a solicitor / property lawyer. The second is a credit assessment of the purchaser, which is delegated to a mortgage broker.

A Terms Contract is a standard Contract for Sale, with three variations:

  1. Like a standard Contract, the purchase price is fixed up front and does not increase later on. But instead of the price being paid by a 10% deposit on signing and the 90% balance price paid a short time later with bank finance, the purchaser pays a small deposit of between $10,000 to $20,000 and pays the balance purchase price by instalments (with interest) over 15 to 20 years. The interest on the instalments is the same as the interest rate the banks charge for low doc loans, because a Terms Contract is form of low doc loan. This means that the interest rate will be a little higher than a full doc loan. The instalment amounts are principal and interest, and can be calculated using a standard home loan calculator. Usually, the instalments are paid weekly, but can be paid fortnightly or monthly.
     
  2. The purchaser moves in immediately they sign the Terms Contract and pay the deposit – they pay the price instalments instead of rent. They also reimburse the Council Rates, Water Rates and Building Insurance premiums the vendor pays - which continue to issue in the vendor’s name because the ownership of the property – the title - does not transfer to the purchaser until the full purchase price has been paid. The purchaser is also responsible to look after the property, in terms of maintenance and repairs. The purchaser can improve the property – by doing renovations and making improvements from painting, to a new kitchen, a bathroom and landscaping, and keep the benefit of these renovations and improvements.
     
  3. The Terms Contract continues for a term, similar to a home loan term of up to 30 years. The term is able to be set shorter if the purchaser has the income to support higher repayments to shorten the term. Importantly, the purchaser can refinance the property at any time – they do not need to wait until the end when the price is paid in full. Usually, after 5 years, the buyer has sufficient equity and a good track record of payments to refinance the vendor finance. Refinancing is often prompted when a purchaser wants to borrow against the property to fund an extension, a new garage or a swimming pool. As each year passes, the purchaser finds it easier to refinance because they are paying down the price. They can boost their equity in the property by making improvements. The purchaser can also sell at any time, provided the sale price covers the balance purchase price outstanding.

Because a Terms Contract is treated as a credit contract at law, then the purchaser must be assessed as creditworthy by a credit professional – the holder of an Australian Credit Licence. Mortgage Brokers not only hold Credit Licence, but they are experts in assessing borrowers, and know all about the responsible credit guidelines that must be followed. The credit professional will assess (a) if the purchaser’s income and financials will support the proposed instalment payments, and (b) if all goes well in terms of the payments, how many years they will need before being able to refinance. The credit professional will issue a letter / email to the seller to confirm their assessment and will produce the vetting documents needed to comply with the Consumer Credit Code. The purchaser pays for this assessment.

If the purchaser checks out, the solicitor / property lawyer acting for the vendor prepares the Terms Contract. The purchaser obtains independent legal advice before they sign.

The Terms Contract is managed by a vendor finance manager, who holds an Australian credit Licence. They collect the instalment payments, pay the property mortgage, the council and water rates, the insurance premiums, and deposit the surplus into the owner’s account. They issue the statements required under the National Credit Code, look after hardship situations, and calculate the payout figure when the Contract is refinanced or the property is sold.


Illustration

The property is sold at a price of $350,000, with a deposit of $15,000 (the up front money), and with the balance price of $335,000 vendor financed and payable by instalments of $537 per week over the next 30 years. In this example, the instalment amount consists of both principal and interest, and the interest rate is assumed to be 7% per annum. The buyer moves in immediately. The buyer pays $65 per week to the owner to reimburse all rates and, insurances. This illustration is an instalment sales form of vendor finance because the price payable is payable by instalments.


How do Instalment Sales work for owners and investors?

  • Owners and investors who use the Instalment Sale form of vendor finance are willing to delay receipt of the price, as a trade-off to receiving the price they want. Instalment Sale vendor finance is not a sale based on price - it is a sale based on price payment terms which are attractive to the buyer. Owners and investors who use instalment sales are the opposite of sellers who sell on the price - sellers on price are usually forced to discount the price for a quick sale.
     
  • Other owners and investors who use the Instalment Sale form of vendor finance do so because banks are unwilling to lend money to a buyer because the property is in a small town or a rural area, or because the property is a shop, factory or office. Most banks define a ‘small town’ as having less than 10,000 residents!
     
  • Yet other owners and investors who use the Instalment Sale form of vendor finance like the higher rate of return on money invested that is available when they vendor finance the purchaser. They like to keep the profit that banks make on lending, for themselves!
     
  • Owners and investors who use the Instalment Sale form of vendor finance are fully secured. This is because the legal title to the property (i.e. ownership) remains in the name of the owner and investor until theTerms Contract has been paid out. This provides owners and investors with excellent security in the event of a default – better than a mortgage security which is what banks hold!


How do Instalment Sales work for buyers?

  • If the buyer’s needs are to buy a home and be able to move in straight away, then an Own Your Home – No Bank Loans advertisement will appeal to the buyer.
     
  • In this case, the buyer has chosen the form of vendor finance known as the Instalment Sale also known as Terms Finance. Instalment Sales are documented in the form of Terms Contracts. Contracts are recognised as legally valid throughout Australia (except in South Australia) and New Zealand.
     
  • A buyer who chooses an Instalment Sale will be buying the property in the usual way, with one significant difference - instead of the buyer needing to look around for a bank loan to pay for the price for the property, the seller finances the price for the property along the same lines as a bank would provide. That is why it is called vendor finance.
     
  • There is no mystery about the many reasons a buyer might choose the Instalment Sale form of vendor finance. These reasons include:
    - having a deposit which is too small for a loan;
    - not having a savings history with a bank for a loan;
    - not having a permanent job for long enough for a loan;
    - needing to have a job history of 12 to 24 months to qualify for a loan;
    - being self-employed – running your own business;
    - needing to re-establish after a financial set-back;
    - needing to wait for 2 years to pass after a black mark has been placed on a credit file, before being accepted as a good credit risk by the banking system;
    - not liking the banking system – prefer to deal with someone they can talk to.
     
  • The Terms Contract is mostly along these lines - the buyer pays a deposit and then pays weekly, fortnightly or monthly instalments to the seller. The instalment amounts will be set to pay the price for the property over 25 or 30 years, just like a bank loan.
     
  • The buyer is encouraged to repay the vendor finance by taking out a bank loan at the 3 year mark (rather than taking advantage of the 30 year term) because bank finance will be cheaper. Vendor finance is offered at a ‘low doc’ interest rate which means that the interest rate payable is set at a 1%, 2% or even 3% above the best interest rate offered by a bank for a home loan product. The seller will use the interest rate payable on their mortgage over the property as the benchmark.
     
  • The great advantage that a buyer has when choosing to buy with vendor finance is that the buyer can move in straight away, compared with buying in the usual way with a bank loan, which can often take two to three months.
     
  • When the buyer moves in under an Terms Contract, they become responsible to pay for council rates, water rates and insurance, and also are responsible for all maintenance and repairs. This is exactly the same as buying in the standard way with a bank loan. Usually, the amount to be paid for council rates, water rates and insurance is calculated and reimbursed to the seller (because the rate notices are issued to the seller) and paid along with the price instalments.
     
  • There are embellishments on this form of vendor finance, such as U fix, you own, U profit which is suitable for ‘handyman’ buyers who have trades skills and who can renovate houses. They trade their time and skills for a price credit, which works for buyer and seller by improving the value of the house.
     

If Instalment Sales work the same way as a bank loan, why are they better than a bank loan for a purchaser?

Although Instalment Sales work the same way as a bank loan, they are better for a purchaser because they are much more user-friendly.

This is because the vendor sets the vendor finance payment terms to pay the purchase price for the property, to suit the purchaser’s circumstances, rather than requiring the purchaser to fit within a standard home loan product that the bank or finance company offers.

Of course banks try to meet this ‘standard home loan’ criticism by offering a choice of home loan products, but the so-called choice is like looking at a supermarket shelf stocked with cheddar cheeses, the cheddars are the same cheese with different packaging, ignoring the fact that there are cheeses other than cheddar such as edam, camembert (and the other 670 well known varieties of cheese) which offer real choices!

Mainstream lenders have a loan approval process which is to put borrowers through hoops to qualify for their standard home loan products. Mainstream lenders have rigid loan approval criteria which means that they will decline loans to borrowers with low deposits, to borrowers with a credit blemish and will tell borrowers who are self employed that they are only eligible for a loan of 65% of value, at most, up to 80% of value!

While lenders are entitled to set whatever loan approval criteria they like, there are many potential borrowers who fall outside these criteria and whose employment / self employed income levels make them good prospects, if a little flexibility is available.

Vendor financiers have the flexibility to offer terms to suit all kinds of purchasers, such as –

  • Vendor financiers can offer low introductory payments, which can rise over time to match rising incomes.
     
  • Vendor financiers can offer low deposits, and even accept the First Home Owner’s Grant as part payment of the deposit.
     
  • Vendor financiers will allow purchasers to improve the value of the home, and if the home is sold as U buy, U fix, vendor financiers will offer to credit a pre-agreed amount as the value of the improvements towards the deposit.
     
  • Vendor financiers will offer a fixed sale price up front, while the purchaser builds their creditworthiness to qualify for a loan refinance in the knowledge that the price will not change.
     
  • Vendor financiers will allow additional payments to be made to pay down the price more quickly, without penalty.


The seventeen things you must know about Instalment Sales

  1. An Instalment Contract is a contract in which the vendor (the seller) agrees to sell the property to the purchaser (the buyer) at a price agreed when entering into the contract, and agrees to lend the purchaser the price payable, less the deposit paid.
     
  2. It is documented by way of a Standard Contract for Sale, with changes made to the completion period, to allow for immediate possession, to provide terms for payment of the price and for immediate possession. The Contract contains extra clauses to ‘supercharge’ the Standard Contract for Sale, namely an Instalment Payment and Licence to Occupy Schedule & a National Consumer Credit Code Disclosure Statement.
     
  3. The completion period is not the standard 30 days (in Queensland), 42 days (in New South Wales), 56 days (in Western Australia) 60 days (in Victoria), it is far longer – it is usually a delayed completion period of up to 30 years.
     
  4. Purchasers are able to pay out the amount of the price owing under the Terms Contract at any time before the end of the completion period. The purchaser is able to do so by refinancing with a lender or by selling the property.
     
  5. The sale price is fixed up front. There are no CPI adjustments or market value adjustments. There is no ‘shared equity’ which is a loan product promoted by some lenders where the lender takes a share of the capital gain in the property.
     
  6. A small deposit is paid which is less than the standard 10% deposit payable under a standard Contract for Sale.
     
  7. The balance price is paid by instalments, on a weekly / fortnightly / or monthly basis. The instalments usually consist of principal and interest, and the amounts payable are calculated to pay out the contract price over the completion period of the Contract. A direct debit authority or a paymaster’s authority is put into place for the payment of the instalments.
     
  8. The price instalments are almost always principal and interest payments designed to pay out the whole amount over the term – the interest rate is set by reference to the interest rate payable on the mortgage that the vendor has taken out upon the property. The interest rate, and therefore the instalment amount, is subject to variation by giving 20 days notice.
     
  9. Purchasers are able to move in to occupation immediately. It is not a residential tenancy - the Purchasers move in under a licence to occupy which is contained in the Terms Contract.
     
  10. Purchasers look after all maintenance & repairs. So when the water heater starts leaking and needs to be replaced, or the fences start to lean, the purchaser is responsible.
     
  11. Purchasers reimburse the vendor for outgoings in the nature of council rates, water rates and insurance premiums. Usually, the reimbursements for outgoings will be calculated in this way – the amount payable over a year is added up, then it is divided by 52 if the payments are weekly, by 26 if the payments are fortnightly, or by12 if the payments are monthly.
     
  12. Most Purchasers refinance (cash out) the Contract after 2 or 3 years – after they have built “equity” and a track record of payments – they have “crossed the bridge into the banking system” where the interest rates are lower and where they can use their “home equity” to borrow against the home to build an extension, a swimming pool, and so forth. Some sell the home for a capital gain.
     
  13. The title to the property remains in the name of the vendor as owner until the Terms Contract is fully paid out. This provides the vendor with “security’ for the payment of the price, particularly in the light of the fact that the Purchasers pay a smaller deposit than the usual 10% deposit.
     
  14. Purchasers protect their interest in the property by being in possession, and by registering a Caveat on the title to the property to protect their equitable interest in the property.
     
  15. Because the Terms Contract is a Credit Contract, the purchasers have all the protection that the National Consumer Credit Code provides.
     
  16. The vendor as owner is entitled to retain their current mortgage over the property. If the owner desires to refinance, then the amount of the refinance must be less than the amount owed by the purchasers.
     
  17. The vendor continues to be entitled to depreciation allowances and other tax benefits on the property because they remain the owner of the property until the purchasers cash out the contract.


Do Terms Contracts continue for the whole term?

While Terms Contracts are written up for terms of 25 or 30 years, they are not intended to go on for many years, nor do they go on for many years in practice.

Terms Contracts should be regarded as the First Stepping Stone along the path of home ownership for a purchaser, the intention being that they be paid out as soon as the purchaser has built up sufficient equity and a creditworthy track record of payments to refinance the vendor finance with a mainstream lending institution.

Some purchasers sell the property, instead of refinancing, to take advantage of the capital gain from the improvements they have made to the property, or an increase in house prices in their suburb or town.

The vendor can build in incentives into the Terms Contract to encourage purchasers to refinance at the 5 year mark. The main incentive is that at the 5 year mark, the interest rate payable increases meaning that the interest rate will be cheaper if the purchasers refinance with an external financier than the interest rate that is payable under to the vendor under the Terms Contract.


What practical issues do purchasers need to deal with under an Instalment Sale?

  1. Purchasers are liable to pay stamp duty on the full purchase price payable under the Terms Contract, often long before completion. In most States, generous exemptions from the payment of stamp duty exist for First Home Purchasers, which relieves them of the burden of paying stamp duty. In other States, First Home Purchasers, and in all States, Second Home Purchasers need to plan to pay stamp duty. As a rule of thumb, the stamp duty payable is 3% of the price.
     
  2. Purchasers are responsible to pay all Council Rates, Water Rates, and although they are able to take out their own insurance, will be asked to pay for the vendor’s building insurance. Most vendors simplify this responsibility by setting an amount to be paid along with the instalments, to cover rates and insurance premiums.
     
  3. The instalments of the price payable under the Terms Contract are subject to variation, when the interest rate varies on the underlying mortgage on the property. The interest rate on the property mortgage is known as the indicator rate, and when the lender varies the indicator rate for the vendor’s mortgage, the vendor varies the instalments payable under the Terms Contract by giving 20 days notice to the purchasers of the new payment amount to reflect this variation.


What practical issues does the vendor need to deal with under an Instalment Sale?

  1. The vendor is responsible to comply with the National Consumer Credit Code, in terms of assessment of purchasers as being suitable to be provided with credit, which is called following responsible lending guidelines, in terms of giving statements of account every 6 months, and in terms of dealing with defaults and hardship applications. Vendors who lack skills or experience in the assessment of purchasers should have a mortgage broker or Australian Credit Licence Holder assist them. Vendors who lack skills in monitoring payments or in dealing with defaults and hardship applications should have a loan manager assist them.
     
  2. The statements of account take the same form as the statement that your lender/mortgagee provides every 6 months – it records interest and charges as debits, and receipts as credits, and has a running balance. There is a separate ledger kept for council rates, water rates and insurance receipts and payments.
     
  3. The vendor is exempt from land tax in NSW, in Queensland and in Victoria from the date that the purchaser takes possession and while an Terms Contact is current for the property.
     
  4. The payment of the vendor finance instalments and the reimbursement of rates and insurance premiums is made using a direct debit system, and is usually outsourced to a loan manager to reduce the administrative burden.
     
  5. Purchasers are liable to pay State stamp duty, which is also known as a property transfer tax, on TermsContracts. A vendors is not liable to pay the stamp duty if a purchaser fails to pay it. As a rule, purchasers who have owned a home in the past will are liable to pay stamp duty. When stamp duty is payable differs between the States – in Queensland, stamp duty is payable within one month after the Terms Contract is entered into, in NSW the time period is three months, while in Victoria, Stamp duty is not payable until after the whole of the price is paid. If stamp duty is not paid when it falls due for payment, interest is payable on the stamp duty (at a penalty rate) until the stamp duty is paid.


What is the legal basis for Terms Contracts?

The legal basis is found in the National Consumer Credit Code, which is part of the National Consumer Credit Protection Act, 2009, being an Act of the Commonwealth Government. The Act makes clear that Terms Contracts are not only legal in all Australian States and Territories, but also that they are covered by the National Consumer Credit Code. This is a summary of section 10


Section 10 National Consumer Credit Code 2010


A contract is an instalment contract if the purchaser –

(i)    Is entitled to possession of the property before receiving the transfer of title;
(ii)   Is paying the price by instalments before receiving the transfer of title; and
(iii)  Is paying a price which totals more than the cash price
 

Because an instalment contract is a credit contract –

(i)    The Owner must comply with the National Consumer Credit Code in terms
        of vetting purchasers and giving a Disclosure Statement; and
(ii)    If the Owner issues more than a handful of instalment contracts – and
        carries on the business of providing credit, the Owner must obtain a
        National Credit Licence.

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