Concessionary Financing, Take-Back Mortgages and Buy-Downs Interest Rates #21

By Gerry Neely
B.A. LL.B.

Column 20 discussed concessionary financing by vendors in the form of take-back mortgages and buy-downs of interest rates on high interest mortgages to be assumed or arranged by a prospective purchaser. The clauses referred to in that column were intended to give the vendor the opportunity of finding a buyer for a take-back mortgage, by making the vendor's acceptance of the Offer subject to the vendor obtaining a satisfactory commitment for the sale of his mortgage at a stated maximum discount.

The second aspect of concessionary financing involves the buy-down of current high mortgage interest rates. The April 12, 1982 article in the Financial Times of Canada referred to in Column 20 quoted real estate agents and builders as saying that mortgage rate cuts attracted more buyers than did reductions in the sale price of homes. Interest buy-downs, by reducing the buyer's monthly payments, might qualify a potential buyer for an institutional loan, where a reduction in the price and therefore the mortgage amount, would not do so.

Let us assume that an offer providing the vendor with all cash has been made, which is subject to the purchaser raising a first mortgage at a stated rate of interest which is current, and the vendor agreeing to reduce the effective rate by 3 points, a fact to be made known to the first mortgagee. The vendor is prepared to accept the Offer if the cost to the vendor of the buy-down is limited. Ideally, as a result of his knowledge of the mortgage market and the practise of local mortgage lenders, the licensee should have made himself aware of the actual costs of the buy-down, assuming that the purchaser is approved and that interest rates remain unchanged between the time of the initial investigation made by the licensee and the time the commitment is made by the mortgage company.

However, interest rates may change, and to avoid exposing the vendor to the risk of an open-ended costly buy-down by having the vendor just agree to pay the amount required to buy-down the rate by 3 points, the following clause might be used with the "subject to financing" clause:

"If the first mortgage is approved, the vendor agrees that there shall be deducted from the proceeds of sale an amount not in excess of $_________, which shall be paid to the first mortgagee in order to reduce the effective rate of interest on the said mortgage to ___%. If the amount is insufficient to reduce the effective rate to ___%, the vendor, at his option, may cancel this agreement or authorize the purchaser to deduct the additional amount required to reduce the effective rate to ___%."

If at the time the Offer is made the licensee is uncertain as to the ultimate source of mortgage money, and therefore the probable cost of the buy-down, the following clause may be substituted for the above clause:

"If the first mortgage is approved, the vendor's obligation to complete this agreement is subject to his approval of the amount required to be deducted from the proceeds of sale to be paid to the first mortgagee, in order to reduce the effective rate of interest to ___%."

These clauses are suggested only as guides to be altered to meet the specific circumstances of each Offer. They are suitable for the present market conditions of decreasing property values and high interest rates, but not for a market where a rise in interest rates coincided with a sudden increase in property values. In that case, the vendor might use his option to cancel the agreement in order to take advantage of the increase in property values.

Concessionary financing arrangements can be complicated, and every licensee should take every step possible to minimize his potential liability, not only to the vendor, but also to the purchaser. Spread the risk around by involving a mortgage broker or other financial advisor, as well as the conveyancers acting for the parties.

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