Re-printed from Ontario Industrial Magazine

When the spread between Prime lending rate and typical Mortgage rates was greater than today it was fairly common for an Offer to Purchase to be conditional upon the seller ‘taking back’ a mortgage to finance part of the purchase price. It was frequently possible for the buyer to pay a lower rate than he could otherwise obtain while the seller received a better rate of return than he would typically get on an equivalent term money market investment.

Today, with a relatively small spread between these rates and greater competition among lenders there are less situations where this type of mortgage is advantageous to the buyer. For the seller, who can invest in mortgage-backed securities there are few situations where taking back a mortgage provides any benefit other than assisting the sale of a unique or difficult-to-finance property.

Nevertheless there are certain market segments and situations where a take-back may be considered.

A take-back First Mortgage is most frequently seen in sales to family members or friends who might have difficulty qualifying for arms-length financing, in Commercial sales of going-concern businesses and in rural residential or land sales. It is less common in arms-length sales of urban residential property.

A take-back Second Mortgage, while more likely for commercial or rural transactions, does have a limited place in the urban residential market.

For the purchase of a going-concern business it may  be that both the buyer and the seller have more confidence in the  cash flows of the business than do the commercial lenders. This is particularly true in the case of a purchase by an employee who may lack the track record that an arms-length lender requires. Also, where there is more cash business than the books suggest, the existing owner may be less reluctant than the bank. Equally, where the assets include a high proportion of goodwill or where the business is only of full value to someone with very specific and unusual skills, an arms-length lender may find that if the down-side materializes, the potential liquidation market is too limited and the liquidation value does not merit the risk.

For the purchase of rural residential property it may be that there is limited demand at the time when the seller wishes to close and that the buyer who is prepared to pay the highest price does not qualify for the loan with a commercial lender. Also, if the property does not meet the criteria for mortgage insurance on high ratio financing ( eg located where there is only a volunteer fire department) a seller take-back may be the only way of obtaining full value.

For urban residential transactions with an arms-length party  there are typically only 3 reasons why a buyer will request a seller take-back

1/ The buyer can get the required level of financing but wants the seller to finance at a lower rate than the bank, thereby in effect cutting the price.

2/ The buyer lacks sufficient down payment to obtain a conventional mortgage and wishes to avoid paying a mortgage insurance premium or paying the full additional interest rate on a regular second mortgage, again in effect looking for a price concession

3/ The buyer cannot get the required level of financing through a regular lender due to inability to prove adequate income, insufficient length of employment ,insufficient length of Canadian residency or past bankruptcy/flawed credit history.

Sellers need to think seriously before taking back a mortgage on a saleable urban residential property, even if they have no better immediate use for the proceeds of the sale. If one wants to invest in the mortgage market one can do so as a completely separate transaction in an amount and on terms and conditions that suit one’s portfolio. Regarding scenarios 1/ and 2/ if the seller needs to make a price concession he can simply cut the price without the hassle, complexity and risk of taking back a mortgage. Under scenario 3/ if the issue is one of past bankruptcy or credit history, it makes little sense to lend to someone who could not persuade any of the very hungry and competitive mortgage lenders to qualify them and you will not be able to re-sell the mortgage at an acceptable discount.

If, however, the issue is one of insufficient time as a Canadian resident or insufficient time at a particular employment a more open-minded view is warranted, particularly if current income coverage is more than adequate and if the buyer was similarly employed in his home country or at a prior position. This is one area where some lenders have not yet fully caught up with all of the changing realities of contract work, self-employment, a more mobile workforce and skilled immigration. Though mortgage insurers such as CMHC can make some allowances for professionally qualified immigrants not every lender knows how to present their information in the best manner to get them approved.

In the event that a seller does favor taking back a second mortgage behind a conventional  first mortgage, I would advise :

A/Never take back more than 10 or 12% of the selling price. As a minimum the buyer should have more invested in the property than you do.

B/ Include a condition upon you being able to re-sell the mortgage at a specified acceptable discount within a reasonable period of time prior to closing and ensure that the interest rate is sufficient to accomplish this.

C/ Include a condition that the Standard Charge Terms of the mortgage will be determined by your solicitor. Among other things this will protect your place in the ‘pecking order’ and prohibit any increase in the First mortgage which would dilute your coverage

D/ Have your Realtor brief you fully on the risks and on what is involved in the event of a default.

Paul Graham is the owner and Broker of Record for BUYERS REALTY INC.  Please direct your questions to paul@buyerscall.com or to his direct line, 905-607-4400