Exploring Affordable Housing Alternatives: The Potential of Seller Financing

The concept of affordable housing can be approached from several perspectives. The reality is that the conventional method of saving 5-20% for a down payment and qualifying for a bank loan remains nearly unattainable for a significant portion of the population. In my line of work, many new home buyers entering the market rely on gifted down payments, assistance in qualifying, or often, both. However, not everyone has the luxury of these options, which highlights the pressing need for affordable housing. What if there were a way to offer a more accessible path to homeownership?

After years of mortgage payments and property appreciation, owners naturally seek to sell and enjoy their retirement. But what are their options upon cashing out? They often turn to low-risk bank investments that provide retirement stability. This decision can pose challenges for the average individual: "What do I do with a cash amount ranging from $500,000 to $1,000,000?" This is where concepts like seller financing and Vendor Take Back Mortgages, typically applied in larger property acquisitions, come into play. Imagine if we could extend this concept of seller financing to new homeowners in Collingwood, or even on a broader scale, across Canada. Property owners looking to sell their primary residences or investment properties could assist new homebuyers in entering the market while still achieving a reliable return on their investments.

"A vendor take-back mortgage occurs when the seller of the home extends a loan to the buyer for a portion of the sales price. The seller retains equity in the home and continues to own a percentage equal to the amount of the loan until the vendor take-back mortgage is paid in full."

Investors can defer their capital gains for up to 5 years, generating a stable return on their untaxed investment. They can stipulate any desired down payment amount, ideally lower to assist new homebuyers. At the end of the 5-year period, they must settle their tax liability, potentially prompting repayment. By choosing this route instead of traditional banking, borrowers avoid strict qualification criteria. I'm not suggesting that buyers should aim for seller-financed multimillion-dollar homes. Rather, this approach caters to homebuyers who are self-employed or face stricter qualifying ratios, allowing them to secure a home instead of being declined by banks. Traditional bank qualification necessitates meeting the posted rate plus a 2% stress test. In contrast, this alternative enables rate negotiation without the stress test requirement.

For instance, a "affordable" household income might be considered as $109,000 annually or less. Assuming this income comes from stable employment of 2 years or more, the bank applies the lowest posted rate for qualification, currently at 5.5% for a 5-year fixed rate with a 25-year amortization. Additionally, a 2% stress test is mandatory, resulting in a qualifying rate of 7.5%. Traditional lending utilizes maximum ratios of 39% for gross debt and 44% for total debt. Based on these figures, a $109,000 household income would qualify for a $442,000 mortgage. In the context of Collingwood's real estate market, this amount falls short.

By bypassing banks and engaging directly with sellers, homebuyers wouldn't need to provide a 20% down payment unless the seller requires it. Buyers may not even have to meet stringent qualifications, although I'll provide an example for illustration purposes. Assuming a $109,000 income, a 30-year amortization (slightly reducing payments for affordability), adhering to bank debt ratios of 39% and 44%, and utilizing a 5% rate without a stress test, the maximum mortgage would be $606,000. Such an approach could make entry-level homes in Collingwood more attainable. This is a single example, and varying ratios could be applied based on the seller's risk tolerance.

Numerous scenarios could be developed; this is just one instance. From the seller's perspective, benefits include deferring capital gains for up to 5 years, or longer, and having a secured investment in the property. This means that, in case of non-payment, the seller can proceed with power of sale to recoup the investment. Unlike investing in the stock market, this approach offers a tangible asset. Additionally, interest earned on each payment can be substantial. For instance, using the $606,000 example, the interest in the first year amounts to about $2,500 per month, alongside $1,000 in principal reduction. This yields a powerful financial advantage. Sellers can sell a property with a predetermined down payment, say 10%, and receive a consistent monthly payment of approximately $3,500 towards both principle and interest throughout the term.

Analytical readers may raise objections, which I acknowledge. They might question the realism of interest rates used or the feasibility of these numbers, suggesting that owners wouldn't likely opt for this approach. It's crucial to recognize that this built-out scenario represents just one possibility. From my experience as an investor, I've learned that win-win situations can always be crafted by understanding the needs of both parties and finding common ground.

This proposal entails many moving parts, mirroring the complexities of the housing landscape. While it won't directly increase the number of available housing units, it can undoubtedly benefit families in the affordable income bracket. In the event that more housing units are needed, the town might encourage the development of high-density, high-rise buildings.

This raises the question: who is working on developing retirement facilities to accommodate these retirees?

Trevor Hough- Collingwood's born and raised real estate investor and Mortgage Coach.