All about Instalment Contracts (also known as Terms Contracts)
How do Instalment Contracts work?
Instalment Contracts are like buying a cake one slice at a time.
The purchaser pays the purchase price, one instalment at a time. The purchaser pays the instalments just like a home loan, except that the purchaser pays the vendor, not a bank.
100 years ago, when land was subdivided and sold, vendors advertised that the price could be paid with easy terms.
Purchasers would go to the land sale auction with a deposit in their pocket and pay the balance price to the vendor over 3, 4 or 5 years by quarterly instalments, with interest at 5% pa added.
Land Sale Poster Blair Street and Wallace Parade, Bondi Beach 1923
The price payment terms
The Contract for Sale provided for payment of the purchase price by instalments, as this article from The Australian Law Journal from 1929 notes:
Today, when a home is sold using an Instalment Contract, the purchaser pays a deposit of 5% of the price and pays the balance purchase price of 95% by instalments of principal and interest over 30 years. That means 360 monthly payments.
An Instalment Contract is a good way for salary earners who have a steady income but low deposit to gain a foothold in the property market.
There is one major difference between purchasing with an Instalment Contract and with a home loan.
It is that with Vendor Finance, the title to the property remains in the name of the vendor until the Instalment Contract is paid out. That is the vendor’s security for payment.
It is different with home loan finance where the title to the property is transferred into the name of the purchaser, and the lender registers a Mortgage over the title as its security.
Because the purchaser is in occupation under the Instalment Contract, the purchaser is responsible to pay the outgoings - Council and Water Rates, Strata Levies, Insurance premiums, and looks after maintenance and repairs.
Although an Instalment Contract can continue for 30 years, it is normally paid out earlier. A purchaser will refinance with a home loan in a 5 to 10 year time frame when they have built up enough equity, because a home loan is cheaper. Or they pay out the Vendor Finance loan when they sell and move on.
Warning – Instalment Contracts are not suitable for use for properties in Victoria or South Australia.
When does an Instalment Contract work?
This is an example:
A house is marketed as “Stop Renting and Buy - For Sale with Vendor Finance (to approved purchasers)”.
The price is $450,000, the deposit is $22,500 (that is, 5% of the price), and the balance price is $427,500 which is payable by instalments of $2,578 per month ($594.53 per week), at an interest rate of 6% per annum over 30 years. The instalments are principal and interest.
The purchaser must be qualified by an Australian Credit Licence holder such as a Mortgage Broker or Finance Broker up front as being able to afford the payments. The Mortgage Broker will also advise the purchaser of the loans that may be available to enable the purchaser to pay out the instalment contract early, when they have built up sufficient equity in the property.
The vendor calculates the purchaser’s monthly contribution for Council and Water Rates, Strata Levies and Insurance Premiums, and adds the amount to the monthly payments. These amounts are reconciled annually. The purchaser is responsible for maintenance and repairs.
The vendor has security for payment because the title to the property remains in the vendor’s name until the price is paid in full. The purchaser’s security is to register a Caveat over the title to the property, to put the instalment purchase on the public record. The purchaser also has security by being in occupation.
Paperwork
An Instalment Contract is a standard Contract for Sale, with two major changes:
- The purchase price is not paid as a lump sum on the normal completion date, the purchase price is paid by instalments over a number of years; and
- The purchaser goes into occupation straight away and is responsible for outgoings (rates, levies and taxes), for the property insurance and for maintenance and repairs.
The instalment payment terns are documented by additional clauses inserted into the Contract for Sale. In Victoria and Western Australia, there are terms payment clauses in the standard form Contract for Sale of Land.
Because instalment payment terms are a form of credit, credit disclosure documents need to be inserted into the Contract for Sale.
The purchaser makes an up-front payment to the vendor when entering into the Contract, which is treated as a deposit. The balance price is payable in the same way as a home loan, which is, by instalments consisting of principal and interest over 25 or 30 years. The interest rate is set at the ‘low doc’ home loan rate (which is higher than the standard home loan rate) and is varied when the interest rate for the reference loan rises or falls.
The purchaser is given early occupation. The purchaser is responsible to reimburse the vendor for Council Rates, Water Rates, Strata Levies, building insurance premiums and to pay for maintenance and repairs from the day they move in. It is called ‘reimburse’ because the rates, levy and insurance renewal notices continue to issue in the name of the vendor.
Stamp duty (also known as Transfer Duty) is payable on the price according to the law of the State where the property is located. First Home Buyer assistance may apply to exempt a first home purchaser from paying stamp duty.
Legal notes
The deposit paid under a Contract for Sale is released to the vendor immediately, instead of being held by a deposit holder until completion takes place. If there is a large mortgage, the purchaser may insist that the deposit is applied against the mortgage.
Because the title to the property remains in the name of the vendor, the purchaser protects their interest by registering a Caveat on the title. A Caveat prevents the vendor from selling the property to anyone else or giving another mortgage over the property.
If the purchaser defaults under a Contract for Sale, the vendor can terminate the Contract and keep the deposit and all money the purchaser has paid, provided that the vendor has complied with the responsible lending obligations when entering into the Contract (see below) and has complied with the loan enforcement procedures under the National Credit Code.
The purchaser is able to sell the property whenever they wish. To do so, they appoint a real estate agent for the sale, and the vendor consents to that appointment. At settlement of the sale, the amount required to pay out the amount outstanding on the Vendor Finance is paid, and the sales proceeds over and above belong to the purchaser.
Stamp duty is payable on the Instalment Contract, the same as on standard Contract for Sale. This means that in most States (except in Victoria), stamp duty is payable before the Contract is completed / settlement takes place).
Legal Restrictions
(1) National Credit Code compliance
Instalment Contracts are credit contracts which are governed by the National Credit Act and National Credit Code, that is, under the National Consumer Credit Protection Act 2009 (Commonwealth) which applies throughout Australia.
The National Credit Act requires that lenders to make “reasonable inquiries about a consumer's financial situation, and their requirements and objectives” - that is, follow the responsible lending rules. A mortgage broker / finance broker (an Australian Credit Licence holder) will be able to carry out the credit assessment according to responsible credit rules.
The National Credit Code requires vendors who give credit to give credit disclosures and documents to borrowers which give information about the vendor finance – such as expected loan repayments, total cost of the loan, features and upfront fees. The Instalment Contract should contain the credit disclosures and documents.
While the Instalment Contract continues, the vendor must still comply with the National Credit Code. They need to issue a loan statement every six months, and deal with hardship applications in the same way as home loan lenders must.
A vendor does not need to hold an Australian Credit Licence to use a ‘one-off’ or even ‘two-off’ Instalment Contract to sell the property. But if a vendor carries on the business of selling property using Instalment Contracts, they need to hold an Australian Credit Licence, or ‘partner’ with an Australian Credit Licence holder who are authorised to provide credit. Note not all mortgage brokers are authorised to provide credit in addition to credit advice.
(2) Restrictions on sale
Restrictions on sale of by Instalment Contracts apply Queensland, Victoria and South Australia. A minor restriction applies to sale of land in a subdivision in New South Wales. An Instalment Contract is typically defined as a Contract where the price is paid by 4 or more instalments (including the deposit and the final payment).
- In Queensland, a restriction applies to Instalment Contracts, which has applied since 1933. It is that once one third of the price has been paid, the title to the property must be transferred (conveyed) to the purchaser, and the balance price is converted into a mortgage in favour of the vendor. This applies to all real estate sales in Queensland, not just to subdivisions. See section 75 Property Law Act 1974 (Queensland).
For this reason, it is normal for a vendor in Queensland to include a clause in an Instalment Contract that once one third of the price has been paid, the purchaser must pay the balance price to the vendor as a balloon payment. The purchaser funds the balloon payment by taking out a bank loan.
- In Victoria, terms contracts (as they call them) are prohibited for use for residential land (that is, houses, home units and land) if the price is less than $750,000. See section 29EA Sale of Land Act 1962 (Victoria) which was inserted in 2019.
A terms contract is defined as a contract where 4 or more payments are made towards the price, including the deposit and the final payment.
If the vendor sells under a terms contract, and has a mortgage or loan secured by mortgage over the property, then the deposit and the purchaser’s instalments are to be paid to a legal practitioner or a real estate agent to be applied against that mortgage or loan until it is repaid. Also, the vendor cannot refinance an existing mortgage while the terms contract is in existence (see section 29M). - In South Australia, instalment purchase contracts (as they call them) are unattractive because the instalments are limited to 4 in number. See section 6 Sale of Land (Conveyancing and Business) Act 1994 (South Australia).
- In New South Wales, the restrictions are limited to the sale of lots in a land subdivision. No restrictions apply to a strata subdivision. The restrictions apply if the sale is by an Instalment Contract or a Property Option. The subdivision must have 5 or more lots. The lots can be vacant land or with a dwelling built on them. The price must be payable by 4 or more instalments.
The restrictions are that a trustee must hold the instalments paid. When 15% of the price has been paid, the title to the property must be transferred into the name of the purchaser, and the purchaser gives a carry-back mortgage to the vendor to secure payment of the unpaid price, and which provides for the instalments to continue. See Land Sales Act 1964 (NSW).
When the Land Sales Act come into force on 31 July 1964, it put to an end to land sales with easy terms such as in the Bondi Beach poster because it was not financially viable for subdividers to transfer the title into the names of the purchaser before the price was paid in full – often they needed the proceeds to sale to repay their loan. It was not long before subdividers found a better alternative: It was a cash sale, where they introduced the purchaser to a finance company to fund the sale price.
Disclaimer
- The video and written commentary contain general information and examples – they are not legal or investment or financial advice.
- Do not rely on the video or written commentary to guide specific property purchases or investment decisions.
- Professional advice is necessary for specific situations because property purchases and investment requires a careful evaluation of circumstances as well as due diligence in selecting and evaluating a property for purchase.
- The paperwork for Vendor Finance needs to be prepared by a property law professional (a property lawyer or conveyancer). It is definitely not DIY (Do It Yourself).
- The word ‘vendor’ is used in some States and Territories in Australia, while the word ‘seller’ is used elsewhere. The word ‘vendor’ is used to refer to both ‘vendor’ and ‘seller’ in the videos and the written commentary.
- The same with the words ‘purchaser’ and ‘buyer’. The word ‘purchaser’ is used to refer to both in the videos and written commentary