The conventional way that most properties are sold is with the buyer paying a percentage of the purchase price as a deposit with the balance due at settlement, normally in about 60 days. 60 days is required so that the buyer’s solicitor/conveyancer has time to prepare for settlement and the buyer’s lender has time to approve finance and execute mortgage documents. At settlement the property title passes to the buyer with a first mortgage held by the buyer’s financial institution.
However another way to sell property is by wrapping, sometimes also called “vendor’s terms” or an “instalment sales contract”. Instead of the buyer paying the full balance of the purchase price at settlement, payment of the balance is instead divided into a series of periodic payments made over a specified period of time. The title of the property remains in the sellers name until the buyer makes their final payment.
Wrapping is a great low or no-money-down strategy that enables an investor to earn significant returns for a relatively small and manageable risk.
John is a property investor. He has found a property for sale in a country town for $180,000. Kylie is currently renting in the same town and is very interested in buying the property. However Kylie only has $3,500 in savings and will not qualify for a mortgage from a major bank. Kylie is excited to learn about the possibility of wrapping. She is eligible for the First Home Owner’s Grant and can comfortably afford repayments of $250 per week.
John offers his “vendor terms” on the basis that the sale price is $200,000 and that interest would accrue on the repayments at the rate of his finance plus 1.5%. The term would be twenty-five years, although Kylie can pay out the balance at any time.
John puts in an offer to buy the property and obtains 80% finance at a variable interest rate of 5.0%.
The numbers would be something like this for Kylie:
Purchase Type Traditional Wrap
Purchase Price $180,000 $200,000
Deposit ( Note 1) $ 36,000 $ 40,000
Less Deposit -($3,500)
Less Fist H.B.G -($3,000)
Settlement costs $ 910
Loan $144,000 $194,410
Interest rate 5.0% 6.5%
Weekly Repayments P & I $194.26 $302.93
Weekly Repayments Interest only $138.47 $243.01
The critical success factors in a wrap are:
1. It’s all about people
The essence of a wrap is that the investor becomes more like a financier and less like a traditional landlord. In fact, all the property expenses in a wrap such as rates, home maintenance etc, become the responsibility of the buyer (in the example above that would be Kylie). This really highlights the need to focus on the person rather than the property, because if you have an unreliable buyer then your cash flow will suffer and your investing headaches will increase dramatically.
2. Build win-win outcomes
There are lots of people who don’t qualify for traditional finance and will be interested in vendor terms, your job is to pre-qualify your buyers to ensure you create win-win outcomes. A large component in pre-qualifying a potential buyer is to ensure that he or she can afford the repayments. If he or she can’t meet the repayments then you won’t be doing anyone, most of all yourself, any favours, as the eviction process is stressful for all.
3. Play by the rules
The wrap laws in each State are slightly different, which means you are going to have to complete some research before launching into wrapping. At the time of writing, wrapping is legal everywhere in Australia except in South Australia.
Some particular rules to be aware of are:
You need to be careful about privacy laws when seeking information about potential buyers, particularly when doing a formal credit check.
Consumer Credit Laws
Whether wrapping falls under consumer credit laws is open to debate, but why risk being caught in an argument that’s easily avoidable? In most States it’s a matter of procedure (which means filling out a form) to comply with the consumer protection laws. Be sure to complete your due diligence before launching in.