Vendor Finance Q & A
Question - Lease Options versus Instalment Contracts
I was studying up on the week end about lease options vs
I was wondering if you can shed some light on this topic
Personally I like the instalment contract idea because it's
more concrete to the buyer
But from all the property online forums I have been reading,
they all seem to prefer the lease options, and some "gurus"
even don't recommend them anymore
mostly from what i can gather it's because it's much easier
to evict if something goes wrong on a lease option compared
to instalment contract
so all the major "gurus" are recommending lease options as
the way to go
Do you see any major problems with instalment contracts
it would seem the main concern they have is in regard to
equity in the deal from the tenant buyer point of view
eg it has been 5 years into contract ..they have paid off
$40,000 and property has gone up $40,000...and now default
do they have any equity in this property?
Lease Options versus Instalment Contracts is always an
interesting topic of discussion. I can contribute these
1. There is usually more up front money available from a
purchaser who wants to buy a property now, under an
Instalment Contract, than from a tenant purchaser who wants
to rent now and buy later under a Lease Option. If you think
of the up front money as security against a default, then
Instalment Contracts usually win out because there is more
money = more security.
2. In some states, such as in Queensland, Lease Options are
commonly used, while in states such as NSW, Instalment
Contracts are commonly used. I am not sure what to attribute
this to, but it could be that home purchasers in Queensland
are more 'try before you buy' than home purchasers in NSW
who are more buying to later re-sell for capital gain. The
retail confidence level might also provide an explanation -
when economic times are buoyant, purchasers will prefer
Instalment Contracts; when economic times are poor,
purchasers will prefer Lease Options. In South Australia,
Lease Options must be used because of a ban on Contracts
where the price is payable by more than 4 instalments.
3. The Residential Tenancy Tribunal can be used to evict
tenant purchasers under Lease Options. The procedure is
cheap and simple, but not much faster than the Court
procedure used for Instalment Contracts. There is a problem
in Queensland, and in some parts of NSW that Residential
Tribunals will not hear eviction cases where there is an
Option attached to a Lease. In states such as Victoria, the
Government has expressly given the Residential Tenancy
Tribunal the right to hear eviction cases where there is an
Option attached to a Lease. Evictions under Instalment
Contracts are processed through the Courts, which is not
cheap, but relatively smoother because the Courts do not
have a hearing date unless the purchasers defend the claim -
which they rarely do. There is always a hearing date in the
4. Issues of equity in the property can be solved if they
arise by cutting a cheque. Usually, the purchaser is
substantially in default, and there is little equity if you
offset the arrears.
How secure is a buyer in an instalment contract or a rent to
Buyers often ask - what happens if the owner defaults on the
mortgage whilst an instalment contract or rent to own is
current, can that buyer lose his money? Does he have
The buyer understands that the bank would have first bite as
they have 1st mortgage, so the question is - what security
does the buyer have?
The same answer applies regardless of whether we are talking
about Instalment Contracts or Rent to Own.
The short answer is –
So long as the buyer makes the payments, the bank loan will
be paid, because the buyer's payments are made into the bank
account from which the bank loan payments are debited. There
will be no default on the mortgage if the bank loan is paid.
The buyer should always secure their rights under the
Instalment Contract by registering what is known as a Caveat
upon the title to the property. A Caveat will protect the
buyer by giving the buyer rights to the property immediately
after the bank's mortgage.
The long answer is -
1. Provided the buyer is paying the instalments on time,
then the owner has sufficient money to pay the mortgage on
time, because these vendor finance arrangements are
structured so that there is always more money coming in from
the buyer, than money going out to pay the loan payments.
Because there is money left over, there is no incentive for
the owner not to pay the bank because that would ‘kill the
2. Because the instalments are usually more than the
mortgage loan payments, the situation has positive cash
flow, and so there is no contribution necessary from the
owner to pay the mortgage loan payments. Contrast the
situation of negatively geared properties, where the owner
must contribute the shortfall between the rent and the
mortgage loan payments.
3. If an owner becomes bankrupt, the owner’s financial
affairs are in the hands of the trustee in bankruptcy. The
Official Trustee in Bankruptcy usually takes no interest in
the Instalment Contract or Rent to Own because they are
considered as an asset of the bankrupt estate which they
cannot sell. This is because the bank is effectively in
control of the property by virtue of holding a first
mortgage. Although bankruptcy is a technical default under a
mortgage, banks are not known to rely upon this default to
exercise their power of sale under the mortgage, provided
the loan payments keep being made.
4. Banks do not like to call loans in default because they
then need to provision the whole of the loan as a doubtful
loan, and to reduce their profits by that amount. Calling a
mortgage in default also means the bank will need to go
through the mortgagee sale process for no reason, if the
payments are being made.
5. As a practical matter, if the owner goes bankrupt and the
bank wants the loan to be repaid, the bank will be prepared
to offer a mortgage to the buyer provided that the buyer has
demonstrated a good track record of payments and sufficient
equity to support a loan, or when the buyer builds up that
track record of payments and builds up equity – usually 12
to 24 months.
6. The buyer should protect their position by registering a
Caveat on the title to the property, and should do so, so
that when the bank searches the title the buyer's name will
appear, and the bank can contact them. When a bank does so,
it is often to put into place a direct debit authority from
the buyer’s bank account to the loan account the bank has
set up, directly, by-passing the owner.
7. Instalment Contracts and Rent to Own arrangements are
only the 'first stepping stone on the path to home
ownership', and the buyer will be expected to refinance
within the banking system within 2 to 5 years. When the
buyer does so, they eliminate their risk that the owner may
Question - Flips and stamp duty
In the near future I will be requiring your services.
However I would like to ask when using the exchange of
Contract in Real Estate transactions here in NSW. What are
the provisions with Stamp Duty does it apply to the full
sale price? I would like to start using this type of
strategy of making quick cash. Who can I contact to find out
more information and what forms if needed, will I need.
Hope to hear from you soon.
Stamp Duty is payable on Contracts for Sale of Land,
calculated at the purchase price, as from the date of
exchange of Contracts.
Therefore if you purchase the traditional way, using a
Contract for Sale and sell the traditional way, using a
Contract for Sale, then you will pay stamp duty on the first
Contract for Sale and the purchaser will pay stamp duty on
the second Contract for Sale, on the price.
The way to get around the payment of stamp duty on the first
Contract for Sale is not to enter into a Contract for Sale.
Instead, you enter into an Option to Purchase from the Owner
- i.e. an option to enter into the Contract for Sale. Stamp
Duty is payable on Options on the option fee paid, rather
than on the price, and so the stamp duty payable is minimal.
To on-sell the property, you enter into a Sale Option,
rather than a Contract for Sale, and nominate the purchaser
to enter into a Contract for Sale directly with the Owner.
Because there is only one Contract entered into, then only
one lot of stamp duty is payable, and that stamp duty is
payable by your Purchaser.
Question - Can vendor finance be paid out early?
Can vendor finance be paid out early legally if vendor and
Yes, vendor finance can be paid out early. At any time in
fact, just like a Bank Loan can be paid out early. Often
there are early repayment fees, if repayment is made not
long after the vendor finance was entered into.
Question - I have a tenant who wants to buy the house
which has been for sale, but has not sold. How do I set it
I own a property in *****, NSW, which is currently rented.
The tenant is keen to buy the property but can't get
I'm keen to sell the property, which has a mortgage of about
180k (floating) and is worth 230-240k.
Can you please advise us the best option for me to sell it
within one to two years time to the tenant?
The property is currently managed by a real estate agency,
through which I try to sell the property recently without
success. Do I have to pay commission on sale amount if I
make a rent to sell agreement? I’m planning to stop the
rental management by the real estate agency soon and manage
Your advice is much appreciated.
Thanks and Regards
Your proposal to sell the property to the tenant fits the
Rent to Own vendor finance arrangement perfectly!
If you can agree on the following ground rules with your
tenant, then I can prepare the legal documentation -
1. Why can't the tenant get finance? If it is insufficient
deposit, then the tenant will need to put aside extra money
each week to build up a deposit. If it is poor credit
history, then the tenant will need to agree to be 'on their
best behaviour' for 2 years to clean up their credit
2. To obtain bank finance, the tenant needs to build up the
deposit money to usually 10% of the price by a combination
of up-front money - a minimum of $5,000 paid to you (often
it is $10,000), and ongoing payments of $150 to $200 per
week (depending on how much needs to be built up).
3. The price of the house is set higher than today's value,
to take into account increases in values over time. In your
case, if you set it at 10% higher than today's value, then
it will work out well if it is a 2 year arrangement.
4. The rent will need to be agreed and fixed for the term of
the arrangement. Again, it will need to be higher than
current market rent, in this case 15% higher is the
5. The weekly payments are therefore the total of rent and
ongoing payments. They can be paid to the agent, or via a
direct debit system called ezidebit.com.au. If paid to the
agent, the agent should reduce their commission from 7.7% to
4.4% because the amount payable is higher than the rent.
6. Whether you are liable to pay agents commission on the
sales agency agreement if you enter into a Rent to Own
arrangement depends on: (a) whether the sales agency
agreement covers an option to sell, in addition to a
Contract for Sale; (b) whether the sale agency agreement has
expired; (c) whether you have terminated the sales agency
agreement after it has expired; or (d) if you come to an
arrangement with the agent to continue to manage the
property during the lease option period (this is the best
7. When you have the information, you should complete my
Instruction Sheet - Lease Option. You will see that I call
the up-front money "up-front option fee" and the ongoing
payments "ongoing option fees" in the Instruction Sheet.
Please also provide a copy of your current Residential
8. For further detailed information, go to the Rent to Own
tab on the website.
I want to ask you something about vendor financing.
1) If I have a mortgage on a house and I wanted to vendor
finance it, will the bank know about it, if they did find
out the whole deal will fall through? Do I have to tell the
bank that I intend to do vendor financing? The clients you
come across do they mainly have their house motgage free
before they do vendor financing?
2) If the wrappee wanted to put a caveat over the property
the bank will find out, will they? What if the wrapees
lawyer insist they caveat the house?
3) Say if I vendor finance a first home buyer will I have to
pay capital gains tax at the beginning of the sale since it
is a purchase and I am vendor financing the rest of the
4) Say if the wrappee is a first home buyer so I will get
the first home buyer grant , do I still ask them for a
deposit on top of that and how much percentage of the sale
price do I charge them, if so?
5) How much is your fee for vendor financing?
The queries about vendor financing –
1) Almost without exception, the houses that are vendor
financed have mortgages upon them. The bank usually does not
care as long as their loan payments continue to be made on
time. If the vendor finance transaction falls over, it does
not affect the bank – it only affects you because you will
have to pay the Bank out of your own pocket.
2) The purchasers’ lawyers often lodge Caveats against the
property. The practice in NSW is that the Lands Office sends
a Notice of Caveat only to the Owner and not to the Bank.
The Bank learns of the Caveat when they carry out a title
search of the property, which they do only if there is a
default under their mortgage or if you ask to refinance.
3) The situation differs according to you circumstances. The
tax determinations that you will find on my website – tab
Tax Issues – state that if there is an enterprise, tax is
paid on emerging profits (as received) rather than up front
as a capital gain.
4) The First Home Owners Grant is accepted as part payment
of the deposit. Therefore if the deposit is set at $20,000,
then $6,000 is paid up front in cash and $14,000 comes from
the FHOG, which is paid about I month after the purchasers
5) My fee is $1,000 inclusive of everything (searches, GST),
Hi Tony, a quick question
Background: Block of land going to be subdivided. House
build on front section.
There is no impediment to selling the ‘house block’ on
vendor finance terms, before the subdivision is registered.
Goal – wrap front house to then build second house and sell
Legally, you enter into the Wrap Contract, the purchaser
moves in and make payments, in the normal fashion. What is
different is that completion of the contract (the cash –
out) is conditional upon registration of the plan of
subdivision. Normally the Contract will provide that the
plan of subdivision is to be registered within 6 months of
exchange of Contracts.
The approval for subdivision is not received as yet?
To set this up, you should obtain advice from a local
surveyor as to the feasibility and cost of the subdivision,
and as soon as you exchange Contracts for the purchase of
the property, engage that surveyor to prepare a plan of the
subdivision suitable for attachment to the Wrap Contract.
Is it possible to wrap the house saying that wrap house and
section only is on say 400sqm not 800sqm? Or can we just
insert a clause in the Wrap Contract that states they are
aware the land will be subdivide during a course of Wrap
You can either exchange WRAP Contracts for the sale of the
house at the front, subdivide the land, and then either sell
the land at the back, or build a new house and then sell the
land at the back.