Why are Installment Contracts popular?

For the vendor (the seller), the reasons why Installment Contracts are popular are –

• The vendor receives a fair sale price
• The vendor can qualify a purchaser themselves to allow them to move in quickly – there is no need to wait for the bank approval process
• The vendor receives income from the purchaser equivalent to mortgage repayments rather than rent, which are set so as to exceed their mortgage payments until the purchaser is ready to “cash out the contract”
• The vendor passes the obligation to pay for maintenance and repairs to the purchaser
• The vendor is reimbursed for outgoings, such as council rates, water rates and insurance premiums by the purchaser from the date the purchaser moves in
• The vendor is no longer liable to pay land tax (in most States) – neither does the purchaser because of the owner-occupier exemption.
• The vendor retains the title to the property in their own name – the purchaser has an equitable interest until they cash out the contract, when the title to the property is transferred into the purchaser’s name.
• The vendor can continue to depreciate the property and obtain tax benefits until the purchaser “cashes out the contract” and the title to the property is transferred into the purchaser’s name.

For the purchaser (the buyer), the reasons why Installment Contracts are popular are –

• The vendor is able to set payment terms to suit the purchaser, rather than the purchaser needing to fit into the straight jacket of a standard home loan offered by the banks – for example, low payments to start, permitting extra payments to be made
• The payments are structured like a bank loan – principal and interest usually over 30 years
• The purchaser can move in immediately when the vendor’s checks are completed
• The purchaser has the freedom to improve the property and keep the increase in value, because the purchase price of the property is fixed up front and never changes.
• The purchaser can refinance or sell the property at any time, and pocket the profit.

If Installment Contracts work the same way as a bank loan, why are they better than a bank loan for a purchaser?

Although Installment Contracts work the same way as a bank loan, they are better because they are much more user-friendly. This is because the vendor sets the payment terms to pay the purchase price for the property, to suit the purchaser’s circumstances, rather than requiring the purchaser to fit within a standard home loan product that the bank or finance company offers.

Of course, banks try to meet this standard home loan criticism by offering a choice of home loan products, but the so-called choice is like looking at a supermarket shelf stocked with cheddar cheese, the cheddar are the same cheese with different packaging, ignoring the fact that there are cheese other than cheddar such as edam, camembert (and the other 670 well known varieties of cheese) which offer real choices!

Lenders have a loan approval process which is to put borrowers through hoops to qualify for their standard home loan products. Lenders have rigid loan approval criteria which means that they will decline loans to borrowers with low deposits, to borrowers with a credit blemish and will tell borrowers who are self employed that they are only eligible for a loan of 65% of value, at most, up to 80% of value! While lenders are entitled to set whatever loan approval criteria they like, there are many potential borrowers who fall outside these criteria and whose employment / self employed income levels make them good prospects, if a little flexibility is available.

Vendor financiers have the flexibility to offer terms to suit all kinds of purchasers, such as –

• Vendor financiers can offer low introductory payments, which can rise over time to match rising incomes.
• Vendor financiers can offer low deposits, and even accept the First Home Owner’s Grant towards the deposit.
• Vendor financiers will allow purchasers to improve the value of the property, and if the house is sold as U buy, U fix, vendor financiers will offer to credit a pre-agreed amount as the value of the improvements against the deposit.
• Vendor financiers will offer a fixed sale price up front, while the purchaser builds their creditworthiness to qualify for a loan refinance in the knowledge that the price will not change.
• Vendor financiers will allow additional payments to be made to pay down the price more quickly, without penalty.

The eighteen things you must know about Installment Contracts

1. 1. An Installment Contract is a contract in which the vendor (the seller) agrees to sell the property to the purchaser (the buyer) at a price agreed when entering into the contract, and agrees to lend the purchaser the price payable, less the deposit paid.
2. 2. It is documented by way of a Standard Contract for Sale, with changes made to the completion period, to allow for immediate possession, to provide terms for payment of the price and for immediate possession. The Contract contains extra clauses to „supercharge‟ the Standard Contract for Sale, namely an Installment Payment and Licence to Occupy Schedule & a National Consumer Credit Code Disclosure Statement.
3. 3. The completion period is not the standard 30 days (in Queensland), 42 days (in New South Wales), 90 days (in Victoria), it is far longer – it is usually a delayed completion period of up to 30 years.
4. 4. The purchaser is able to pay out the amount of the price owing under the Contract at any time before the end of the completion period. The purchaser is able to do so by refinancing with a lender or by selling the property.
5. 5. The sale price is fixed up front. There are no CPI adjustments or market value adjustments. There is no „shared equity‟ which is a loan product promoted by some lenders where the lender takes a share of the capital gain in the property.
6. 6. A small deposit is paid which can be part paid with the First Home Owners Grant, and by „sweat equity” if pre-agreed. The deposit is less than the standard 10% deposit which is payable under a standard Contract for Sale.
7. 7. The balance price is paid by instalments, on a weekly / fortnightly / or monthly basis. The instalments usually consist of principal and interest, and the amounts payable are calculated to pay out the contract price over the completion period of the Contract. A direct debit authority or a paymaster’s authority is put into place for the payment of the instalments.
8. 8. The instalments are almost always principal and interest payments designed to pay out the whole amount over the term – the interest rate is set by reference to the interest rate payable on the mortgage that the vendor has taken out upon the property. The interest rate, and therefore the Installment amount, is subject to variation by giving 20 days notice.
9. 9. The Purchasers are able to move in to occupation immediately. It is not a residential tenancy – the Purchasers move in under a licence to occupy which is contained in the Contract for Sale.
10. 10. The Purchasers look after all maintenance & repairs. So when the water heater starts leaking and needs to be replaced, or the fences start to lean, the purchaser is responsible.
11. 11. The Purchasers reimburse the vendor for outgoings in the nature of council rates, water rates and insurance premiums. Usually, the reimbursements for outgoings will be calculated in this way – the amount payable over a year is added up, then it is divided by 52 if the payments are weekly, by 26 if the payments are fortnightly, or by12 if the payments are monthly.
12. 12. If the Purchasers are first home buyers, then as Purchasers under Installment Contracts they do qualify for First Home Purchaser concessions, including the First Home Owners Grant & Stamp Duty Exceptions up front when they enter into the Contract.
13. 13. Most Purchasers refinance (cash out) the Contract after 2 or 3 years – after they have built “equity” and a track record of payments – they have “crossed the bridge into the banking system” where the interest rates are lower and where they can use their “home equity” to borrow against the home to build an extension, a swimming pool, and so forth. Some sell the home for a capital gain.
14. 14. The title to the property remains in the name of the vendor as owner until the Installment Contract is fully paid out. This provides the vendor with “security‟ for the payment of the price, particularly in the light of the fact that the Purchasers pay a smaller deposit than the usual 10% deposit.
15. 15. The Purchaser protects their interest in the property by being in possession, and by registering a Caveat on the title to the property to protect their equitable interest in the property.
16. 16. Because the Installment Contract is a Credit Contract, the purchaser has all the protection that the National Consumer Credit Code provides.
17. 17. The vendor as owner is entitled to retain their current mortgage over the property. If the owner desires to refinance, then the amount of the refinance must be less than the amount owed by the purchaser.
18. 18. The vendor continues to be entitled to depreciation allowances and other tax benefits on the property because they remain the owner of the property until the purchaser cashes them out.

Do Installment Contracts continue for a long time?

While Installment Contracts are written up for terms of 25 or 30 years, they are not intended to go on for many years, rarely do they go on for many years in practice.

Installment Contracts should be regarded as the First Stepping Stone along the path of home ownership, the intention being that they be paid out as soon as the purchaser has built up sufficient equity and a creditworthy track record of payments to refinance the vendor finance with a mainstream lending institution.

Some purchasers sell the property, instead of refinancing, to take advantage of the capital gain from the improvements they have made to the property, or an increase in house prices in their suburb or town.

The vendor builds in incentives into the Installment Contract to encourage purchasers to refinance at the 2, 3 or 4 year mark. The main incentive is that at the 2, 3 or 4 year mark, the interest rate payable increases meaning that the interest rate will be cheaper if the purchaser refinances with an external financier than the interest rate that is payable under to the vendor under the Installment Contract.

What practical issues does the purchaser need to deal with under an Installment Contract?

1. 1. The purchaser is liable to pay stamp duty on the full purchase price payable under the Installment Contract, often long before completion. Fortunately, in most States, generous exemptions from the payment of stamp duty exist for First Home Purchasers, which relieves them of the burden of paying stamp duty. Second Home Purchasers need to plan for stamp duty.
2. 2. The purchaser is responsible to pay all Council Rates, Water Rates, and although they are able to take out their own insurance, will be asked to pay for the vendor’s building insurance. Most vendors simplify this responsibility by setting an amount to be paid along with the instalments, to cover rates and insurance premiums.
3. 3. The instalments of the price payable under the Installment Contract are subject to variation, when the interest rate varies on the underlying mortgage on the property. The vendor can vary the instalments by giving 20 days notice to the purchaser.

What practical issues does the vendor need to deal with in an Installment Contract?

1. 1. The vendor is responsible to comply with the National Consumer Credit Code, in terms of assessment of purchasers as being suitable to be provided with credit, in terms of giving statements of account every 6 months, and in terms of dealing with defaults and hardship applications.
2. 2. The statements of account take the same form as the statement that your lender/mortgagee provides every 6 months – it records interest and charges as debits, and receipts as credits, and has a running balance. There is a separate ledger kept for council rates, water rates and insurance receipts and payments.
3. 3. The vendor is exempt from land tax in NSW, in Queensland and in some other States while an Installment Contact is current for the property.
4. 4. In NSW and in Victoria, the First Home Owner’s Grant is paid when an Installment Contract is entered into, and is therefore able to be used to part-pay the deposit. In Queensland it is not payable for 12 months afterwards. In Tasmania, it is not available until the Installment Contract is paid out.
5. 5. The payment of the instalments is through the use of a direct debit system, and can be outsourced to a real estate rental manager.

Installment contracts can work well for some people. They are not for everyone. If you can get a traditional bank loan then this can be an option that works well for you. However, if you haven’t got a big deposit or you have some other reason why you may be unable to get a traditional bank loan, then purchasing this way can be a very good way to buy a property.