How To Avoid The Most Expensive Mistake Home Buyers Make
So you’ve spent hours researching homes on the internet, inspected what feels like a million houses and organised various building reports, contract reviews and your mortgage pre-approval.
Buying a house is usually stressful enough without having to trawl through the sales contract. But because vendors and agents will normally try to pressure you to sign the dotted line ASAP so they can finalise the sale, it is up to an eagle-eyed lawyer/conveyancer or if not, YOU, to check the contract to ensure you’re protected.
Avoid This Expensive Mistake Home Buyers Make
Include a “Subject to Finance” Clause
Contracts for sale can include a number of special conditions to protect you in situations that are out of your control. Some common ones include:
- a “subject to satisfactory building and pest inspection” clause in case there are major issues with the house
- a “subject to planning or building approval” clause for a property investor who wants to renovate or develop the property
- a “subject to finance” clause to make sure you don’t lose your deposit if your finance doesn’t come through in time
Here we’ll focus on a “subject to finance” clause and why this one clause that can protect you from not only losing your deposit but also potential further legal action. Not including this clause has become the most expensive mistake Home buyers make.
What is a “Subject to Finance” Clause?
A “subject to finance” clause makes a property sale conditional on finance being approved. In other words, even if you sign on the dotted line, if you are unable to get a loan approved then you aren’t bound by the contract and are able to walk away from the purchase.
It is essential to have a “subject to finance” clause where a loan has not been approved unconditionally – this is the case for a pre-approval or any other loan “approved with conditions”.
What does a “Subject to Finance” Clause say?
Typically a “subject to finance” clause will state:
- The contract is subject to the lender approving the loan by a certain date (e.g. within 14 days of signing)
- The buyer has done everything reasonably required to obtain approval of the loan
- The buyer can terminate the contract if the loan is not approved within time by providing written notice to the vendor
After you have the “subject to finance” clause added they will ask you which bank – we always recommend putting “any reasonable lender, for an amount required to complete settlement” to keep your options open.
By including a “subject to finance” clause, this means your deposit is safe if you aren’t able to organise finance in time. It can also give you breathing room even when you are 100% certain you can meet the conditions of your pre-approval e.g. by making sure the valuation is in line with your offer price so you can double-check there’s nothing you’ve overlooked.
Why almost all buyers need a “Subject to Finance” Clause
To buy a property in Australia, most people will need to borrow at least some of their purchase price from a lender. This means that before settlement, a buyer needs to be 100% sure the bank will approve their loan so they have the necessary funds to complete the contract.
The consequences of not being able to finance by settlement without a “subject to finance” clause can be DISASTROUS. In the best case scenario, it can mean scrambling around for a loan within the short settlement period. This can mean you don’t have enough time to properly consider the loan conditions being offered, leaving you out of pocket with higher interest rates and fees. It could also mean paying penalties under the contract for late settlement – this can often run into thousands of $$! You can see why it’s the most expensive mistake home buyers make.
The worst case scenario though is not being able to settle and having to forfeit your entire deposit (usually 10% of the purchase price). With an average price of $636,000 for residential property in Victoria (per the Reserve Bank of Australia), this means you’ll lose out on average $63,600! On top of that, you are liable to be sued by the vendor for damages if they are unable to resell the property at a price the same or higher than what you offered. And that’s not all – you’ve also just missed out on your dream home!
Most real estate agents know the consequences of not including a “subject to finance” clause but they are NOT obliged to let purchasers know (after all, they’re acting for the vendor). It’s important for buyers, particularly those who are borrowing a high % of the property value or who have a small deposit, to put a “subject to finance” clause in, as it is especially hard to find finance at short notice in these situations.
CASE STUDY- A $52,000 Lesson
A young couple bought a house in Bundoora, Victoria for $520,000 after they had been to a mortgage broker and had written pre-approval from a bank to spend $550,000, subject to valuation and “acceptable security” (this is a standard clause in all pre-approvals).
They had a 10% deposit and a first home buyer concession to reduce stamp duty.
As first home buyers, they were so excited about their dream home that they signed the contract without running it past their solicitor or broker.
They then sent the broker the copy of the signed contract and the broker proceeded to send it to the bank to finalise the finance. To their surprise, the bank DECLINED the loan and this young couple were going to lose their 10% ($52,000) deposit…
Long story short, they found Mortgage Corp through a friend’s recommendation.
Luckily, we were able to assist, because what the other broker and client hadn’t understood was that behind the back fence of the property there were some major power lines. Because of our industry knowledge we knew that most lenders have a policy of making sure they don’t lend to properties within 100 metres of these power lines.
We sat down with the client and provided some solutions with one or two lenders that would potential provide finance, but the couple had to either:
Because the most they could borrow was 80% of the house value (and this was only available with 1 lender out of more than 20 lenders).
If we hadn’t come up with a solution the young couple would have lost their deposit (i.e. their life’s savings!). The best thing they could have done in this situation was to simply include a “subject to finance” clause to give them an easy way out.
Case Study: How a “Subject to Finance” Clause A 1st Home Buyer $10,000!
We had a client who was a young lady looking to purchase her first home in Melbourne. She wanted to live close to the CBD and because of her limited deposit, our loan specialist recommended she looked outside of the CBD such as South Yarra or Brunswick as most lenders had restrictions on lending in the CBD.
She got her pre-approval for a maximum loan amount of $450,000, subject to valuation. She came back 2 weeks later with a contract with a “subject to finance” clause included and a $10,000 deposit.
We asked her about the size of the apartment because it wasn’t disclosed in the contract. What the agent hadn’t told our client was that the one bedroom apartment was only 39 square metres, which is generally not an acceptable property to most lenders because of the limited market available for small size apartments. Luckily, because she had the “subject to finance” clause in the contract, our client was able to get her $10,000 deposit back and cancel the contract.
Imagine how she would’ve felt if she had lost the $10,000 deposit as a young first home buyer…
!! A pre-approval is not approved finance!!
Most home buyers and investors know they need to get a pre-approval before they start looking for a home or investment property. Many buyers also think that having a pre-approval in place means their finance is guaranteed. Whilst this is correct 99% of the time, you don’t want to be part of the 1% that loses their ENTIRE DEPOSIT because their pre-approval doesn’t translate into an approved loan and you don’t have a “subject to finance” clause to protect you.
A pre-approval is essentially a document provided by a lender that states that provided all the conditions, information and assumptions the lender makes are correct, they will be able to lend to you a certain amount of money. This is not a formal approval and buyers can still be exposed if the lender changes their mind before settlement. Read Jenna and Howard’s case study here for more tips on what to do if this happens.
Lenders have a number of reasons NOT TO LEND TO YOU EVEN AFTER YOU HAVE PRE-APPROVAL including:
- Your pre-approval period has expired – most pre-approvals are valid for 3 or 6 months, which means if you haven’t bought a house within the period outlined in your preapproval, you’ll need to get a new pre-approval before the expiry date
- You haven’t met the conditions of your pre-approval – this includes verifying the information you provided the lender are all correct
- The valuation of your intended property purchase comes out lower than expected – meaning you can’t borrow as much
- The lender’s policies have changed since the time they granted you pre-approval – meaning they will decline your loan
Be sure to always read your pre-approval letter carefully for the loan amount and your loan conditions. Your broker can help you organise the pre-approval and understand the conditions you need to satisfy. Don’t make the mistake of not knowing the conditions and expiry date of your pre-approval.
What Can Happen When You Don’t Meet the Conditions of Your Pre-Approval?
Let’s use an example to illustrate this. A home buyer, let’s call her Fiona, receives a written pre-approval from the bank that states that she can borrow up to $500,000 for up to 80% of the purchase price of a property, based on her salary of $75,000.
Within 3 months, Fiona finds a great three-bedroom investment property for
$600,000. “Great!”, she thinks, “the bank is sure to lend me enough to cover 80% of the purchase price of $480,000.” She signs on the dotted line and pays the deposit from her savings.
Unfortunately for Fiona, due to personal circumstances, she also changed to part-time hours between the time of her pre-approval and signing the contract, meaning her salary has decreased to $60,000. This means the conditions of her pre-approval are no longer satisfied!
When she turns up to get her final approval from the broker, imagine her surprise when his broker tells her he’ll only be able to lend her $400,000 not
$500,000! This means she won’t be able to settle on the property – and will also lose her deposit of $60,000 if she doesn’t have a “subject to finance” clause!
When NOT to Include a “Subject to Finance” Clause?
As mentioned above, vendors would prefer not to include a “subject to finance” clause. After all, they want to be certain that their house is SOLD. A “subject to finance” clause means the sale can fall through if the buyer doesn’t get that final approval from the bank.
Therefore, you might be able to negotiate a better price with the real estate agent by taking out the “subject to finance” clause.
For example, if you offered $620,000 without a “subject to finance” clause and another buyer offered $630,000 with a “subject to finance” clause, the agent is likely to accept your offer because it’s going to be a done deal for their client! Meanwhile, you’ve essentially saved yourself $10,000!
However, before considering deleting the “subject a finance” clause make sure that:
- You’ve got a written pre-approval
- You’re able to meet the conditions of your pre-approval
- You’ve got enough deposit
- Your mortgage broker has gotten a bank valuation on your house (if you’re going to leverage your house’s equity)
- You’ve done some research on sales data in the area and your broker has helped you check the house value of the property you’re proposing to buy
- You’ve also sought advice from your lawyer or conveyancer Auctions are an exception!
In Victoria, auctions are an exception to including a “subject to finance” clause. A contract for sale at auction does away with many buyer protections found in standard contracts for sale including:
- No cooling-off period
- Not being able to change the contract to a longer settlement period
- Not being able to make the contract subject to any other further conditions such as obtaining finance or a valuation
This is why it is important to negotiate changes to a contract BEFORE THE AUCTION. Otherwise, if you succeed at auction, you are stuck with the contract presented to you at auction.
However keep in mind that even if you are the winning bidder, you can still refuse to sign the contract – without a signed contract you are under no obligation to buy the property. Some real estate agents might argue that you have to sign but ignore them – you can definitely walk away. However be prepared to be chased down the street if you try to walk away after lodging the winning bid at the auction!
What Should Vendors do about “Subject to Finance” Clauses?
On the other hand, if you’re a vendor, “subject to finance” can sometimes be a deal breaker. For example, you might be looking at purchasing another house after selling your current property and want to be ABSOLUTELY SURE your sale is finalised so you can settle on your new property!
You might be able to avoid having a “subject to finance” clause inserted by hiring a good real estate agent that understands buyers and can spot a genuine buyer and get them to commit, or by hiring a good lawyer who can help you negotiate.
However, if a buyer insists on a “subject to finance” clause, thankfully in most cases it’s not a big issue and most buyers will come through to settlement. However to alleviate any concerns:
- Make sure you get as much deposit as possible – this demonstrates their commitment and ability to raise finance; or
- Hope the buyer has a good broker or better yet, recommend a good broker to the buyer to make sure they are able to get their finance approved so your sale can proceed to settlement without a hitch.
For vendors, “subject to finance” can be a good thing too as it can actually lead to a very smooth transaction.
If a buyer hasn’t cancelled their contract within the “subject to finance” period then once that has passed, you will know that their bank has approved their loan and it’s unlikely they will be unable to settle on the property down the track. For greater comfort, you can ask your selling agent to get a copy of their pre-approval letter or confirmation of existing finance. You might also be able to use a “subject to finance” clause as a bargaining chip – for example, if someone is pre-approved to spend $650,000 but is willing to offer slightly more (say $670,000) but with a “subject to finance” clause due to interest from other buyers, this means you could potentially achieve a higher price on your sale.
Your next step to getting the right loan & loan structure for long term investment success
There’s no doubt that analysing the many factors that go into a loan can be confusing and time-consuming. At Mortgage Corp, we take the time to understand your goals and unique situation and then come up with a mortgage strategy. We are committed to not only getting you the right loan but more importantly, getting you the right loan structure for long term investment success. Our strategic approach means we take a long-term view, aimed at maximising future investment options so you can build a successful property portfolio faster… and reach your financial freedom sooner.
About Neil Carstairs
Neil is the founder of Mortgage Corp, an active property investor and awarding winning MFAA accredited finance broker with more than 10 years’ mortgage broking experience. Currently, Neil is one of only few MFAA Certified Mentors in VIC/TAS region.
He is known for his strategic approach to investing and ability to reach fast, successful outcomes for clients where his industry peers could not. Connect with Neil on LinkedIn.