Buying off-the-plan is a choice that many investors and home buyers make. Many will do this with the “perceived” safety net of a pre-approved loan. However, along with a number of general risks associated with purchasing off-the-plan, there are additional risks directly resulting from the property, certain market trends, and the interest rate rises.
Different impacts of a booming property market vs a risky property market
The property market boom in previous years saw interest rates at record lows, making it both a purchasers’ and sellers’ market. Low interest rates allowed for many new homeowners to break into the property market and others to add to their investment portfolios.
However, since May 2022, we have seen a significant change in property trends, with house prices falling and interest rates rising (significantly at the time of writing).
Between May 2022 and November 2023, the cash target rate increased from 0.10 to 4.35 and all big four banks in Australia have been passing on each rise in full. So, where does this leave purchasers who have loan pre-approvals? Particularly those choosing to buy off the plan.
Investors in particular have been attracted to purchasing off-the-plan given that they pay the agreed purchase price stipulated in the contract of sale and then, once the construction has been completed (which can sometimes take several years), they have typically settled on a property which has significantly increased in value without having to actually pay for the increased capital value.
However, this highly sought after benefit may no longer be readily available with a property market seeing price decreases and high interest rates. When considering these two factors, there is the risk that when the construction is complete investors may be settling on a property that has significantly decreased in value.
How do lenders react to a risky property market?
Lenders (banks etc) are obviously very cautious when it comes to lending in a volatile property market.
The rise in interest rates and falling house prices can often impact a bank’s policies on loan pre-approvals. This, in turn, will impact purchasers, particularly those buying off-the-plan, where the loan is not being called upon until years after it was pre-approved.
How are loan pre-approvals impacted in a volatile property market?
Obtaining loan pre-approval from your bank (or other lender) can be of great assistance when purchasing your home or investment property and can be reassuring. It gives purchasers the confidence to bid or purchase. However, pre-approval for purchases off-the-plan can be risky.
What is a loan pre-approval?
A loan “Pre-approval” is not approval of your loan. The bank will provide you with pre-approval before you begin the formal loan application. Pre-approval is usually given on a conditional basis and the changing of any of your personal circumstances (such as employment, marriage, children), banking policies, rate rises, and market conditions may affect your “pre-approval” status. Pre-approvals are non-binding on either you or the bank, meaning neither you nor the bank must proceed with the loan.
When purchasing off-the-plan and making an application for a formal loan, banks will often require a property valuation. This will, amongst other things, contribute to determining how much they are willing to lend you.
Generally, banks may recommend that you wait until the property is constructed before you apply for a formal loan, as the bank will need to value your property at the time of entering the loan. However, depending on your eligibility, your bank may have already given you pre-approval for the loan.
Whilst having pre-approval is great, it is important to note that the banks will still require a valuation of your property after construction is completed. This makes it a “conditional pre-approval” until the valuation of your property is complete, which could be several years after the pre-approval was provided by the bank.
When property trends see prices drop and interest rates rise, the main risk facing purchasers with the abovementioned valuation requirement (with their “conditional pre-approved loan”) is that banks are making stricter considerations when providing loans.
Banks will re-evaluate the ability of many purchasers’ abilities to meet loan requirements and obligations in the event of further rate rises and property price drops.
If your bank is uncertain about your ability to fulfil or meet your loan requirements at a point in the future when the property settles/construction is completed, they may have a clause in the loan contract enabling them to reduce the amount of funds initially agreed upon in your loan pre-approval.
This may leave you shortchanged at the time of settlement when the full amount is due and payable.
If you have already signed the contract, this might mean that you are now potentially stuck in a contract for an off-the-plan purchase with the vendor where you don’t have sufficient funds to fulfil your contractual duties as the purchaser.
What can you do if your loan pre-approval figure changes?
If your loan pre-approval conditions change, including the amount the bank agreed to loan you have some options, although they are not ideal nor guaranteed to help.
Negotiate with the vendor and/or your lender
You may try to:
- enter into negotiations with the vendor to see if they might allow for an extension of time; or
- negotiate with your bank.
However, if negotiations fail both with the vendor and the bank, you may be forced to default on settling the property. This means that, under the contract, you will forfeit your deposit (usually 10%), and the vendor must try to sell the property to another purchaser. However, if they are unable to sell the property for the same price or more than it was sold to you, the vendor is entitled to sue you for the difference in price.
Seek a loan from a second lender
You may be able to negotiate borrowing a further amount of money from a second lender who will become a second mortgagee on your property. However, these types of loans often attract exorbitant fees and interest rates as there is a higher risk to the lender.
Precautions to take before buying off-the-plan in a volatile property market
Given that the above-mentioned options are not ideal and are costly to purchasers, this scenario highlights the importance of taking additional precautions prior to entering into contracts for any property purchase, especially ones off-the-plan.
Such precautions entail seeking sound financial advice about your ability to secure and meet loan obligations and what those loan obligations might be or how they might change.
It is also prudent that you speak with your bank about conditional loans or pre-approvals to grasp a full understanding of what these mean and how changes to interest rates and house prices might impact you.
Get help from a property lawyer
Alongside seeking advice from a financial advisor, it is also prudent for any property purchaser to seek legal advice before entering into any contract of sale. We will discuss your specific circumstances with you, review any contract of sale and advise you on any pitfalls you may face either now or in the future.
Contact David Davis Lawyers
Phone: 03 9014 1299
Email: admin@ddavis.com.au