Buying a property “off-the-plan” is the purchase of a property that hasn’t yet been built, the decision being made on the basis of the proposed plans for construction. The most commonly “off-the-plan” properties are apartments, units and townhouses.
The second type of off-plan purchase is the purchase of unregistered land.
An unregistered land purchase is when a developer subdivides a larger block of registered land through an as yet unregistered plan of subdivision. The plan of subdivision must be approved by the local council and registered before settlement can occur. When you sign a contract to buy an unregistered land, you are buying a “Lot” an unregistered subdivision plan. Your actual lot doesn’t yet exist, so there is the potential that there could be changes to boundaries, easements etc.
There has always been a degree of risk associated with purchasing residential properties off-the-plan. The end product finishes might not meet expectations in an apartment or unexpected easements or changes to the size of a lot with unregistered land, may result in you ending up unhappy with the property you have purchased.
The potential upsides to these purchases, particularly in rising markets where you may be able to lock in the purchase price, means your property may increase in value before you settle.
In almost all cases, unless your purchase is very close to completion of the building or registration of the land (ie within 90 days), as a purchaser you will be required to commit unconditionally to the purchase without being able to secure your finance until settlement is almost due.
Our focus here is to help you understand the finance process and the risks you will need to consider so that an informed decision can be made.
Firstly, your finance clause doesn’t offer much protection at all…
Most contracts include a finance clause, however it is usually only between 14 and 28 days. In the early stages of marketing a development or land release, registration and therefore settlement can be anything from 6 months to 36 months away (even before the inevitable delays).
If settlement is more than 90 days away, it is highly unlikely that the developer will be in a position to allow a valuer access to inspect the property. In the case of a proposed new building, it’s unlikely that there will be anything to inspect as construction may not have commenced.
In this instance, the best that can be done is a pre-approval to understand that based on current your current income, commitments, and circumstances that the bank would approve you as borrowers for that finance. Be very sceptical of anyone who promises you more than this, there will be a catch. A pre-approval is a long way from the comfort of an unconditional finance approval.
Even if the development is at a point where the valuer can gain access, the vast majority of lenders will require that a property settles within 90 days of the date of the valuation, if this doesn’t occur due to delays, even an unconditional approval can lapse!
If you decide to proceed with an off-plan purchase before a formal or unconditional approval is possible, you will essentially have to sign off the finance clause, giving up your right to use the fact that you can’t raise finance later when settlement is called to cancel the contract.
Valuation risk
Whilst you wait in anticipation for the settlement date, and the date 90 days prior to expected settlement when the property can be valued the property market will likely move. It may be in your favour and rise, it could be static, or in the stuff of nightmares it could fall, a lot.
When the valuation is done, if it comes in at less than what you contracted to pay for the property, the lender will base the loan amount on the lower of the contract price or the valuation.
For instance, if you had contracted to buy a property for $ 500 000 and were planning to borrow at 80%, you would have paid a deposit of $ 50 000 and ideally, you would have locked in access to funds for the remainder of your deposit plus your stamp duty (approx. $ 70 000). This could either be cash savings, or a loan raised against another property. “Plan A” is that the bank would lend you $ 400 000 to complete the purchase.
If the valuation comes back at $ 450 000, the bank will now only lend you $ 360 000, leaving you to find the remaining $ 40 000, usually at very short notice.
If you can’t come up with the extra cash, you could try to borrow the additional $40k taking your loan up to 90% of the valuation. This will cost you lenders mortgage insurance of around $ 8 000 in this example.
If you can’t do either of these, you may have no choice but to cancel the contract. This could mean the loss of your $50 000 deposit and potentially at risk of being sued by the developer if are unable to resell the property for what you were contracted to pay. When valuations come in short, this is a very real risk.
A way to mitigate this is to have a “Plan B”, which takes the potential of a low valuation into account, for example – accumulating extra savings while waiting for the property to complete or arranging for the possibility of support via a family guarantee as back up.
Lending policy changes
If your pre-approval is done properly and fully assessed (which can take some manoeuvring through the system by a broker who knows what they’re doing), it is valid for 3 months. In some instances, lenders will honour the pre-approval for up to 6 months subject to you providing proof of continued employment. It will always be subject to a valuation when the property is complete, and there being no changes to your financial position.
In most instances, however, because of the frequency of materially credit policy is now changing, most lenders will require a new application after 90 days. Ironically, the process of continually re-applying for a pre-approval for peace of mind may result in your application eventually being declined because of too much activity on your credit file.
If during the period from the expiry of the pre-approval until settlement of the loan, your personal circumstances change, lending policy changes, or interest rates rise substantially impacting on your borrowing capacity, this is where things can start to get exciting for all the wrong reasons.
Here are some examples of the types of issues that can and do come up:
Changes to your circumstances:
- An unexpected job loss, or a reduction in work hours, lowers borrowing capacity.
- A job change comes with a probation period which is a problem for some lenders (and most LMI providers)
- An unexpected addition to the family brings about both maternity leave and higher living expenses, again – reduced borrowing capacity.
- New loans/commitments taken on reduce your borrowing capacity. We advise clients to avoid this, but if the off-plan completion timeframes blow out (which they almost always do) and the family car dies, sometimes you have little choice.
- You forget to pay a telco or utility bill and pick up a blemish on your credit file, even a little one of these can be a show stopper across the majority of banks and lenders. (If you can get it done after one of these the rate will usually be horrible)
Changes to lender policy or appetite:
- Interest rates rises and with that the qualifying rate is higher, which reduces your borrowing capacity
- Lending policies have changed and the LVR is now restricted further. Examples include lenders deciding overnight that they won’t touch new builds, or will only finance up to 70% LVRs in some areas.
- Lenders reduce their lending appetite for they type of property you purchased off-the-plan, as a result of a saturation of properties in the building/suburb/area where you purchased. This most commonly happens in large buildings where they may already have significant exposure. Lenders mortgage insurers also have strict maximum percentages that they will fund in any one development. If you don’t get in early, you may be knocked back simply because there were too many applications, for the same building, in the queue ahead of you.
It is one thing to make your own contingency plans for a change in your circumstances, which we always recommend clients do, but quite another to have the rug pulled out from underneath you because the lender changes their position. In these instances, it can be necessary to look to niche lenders to secure finance. This is not always possible, and can be expensive when it is.
When is off-plan less risky?
This ties back to the magic “90 days” and when a valuer can gain access. If you can find a development that is close to completion or land that is due to register and settle within 90 days, you can obtain full finance approval upfront and avoid all these headaches, even if it is technically still an off-plan contract. In this scenario, it essentially becomes a normal contract where you can lock your finance in before you are committed.
So, after all this doom and gloom, where do we stand if we can’t find anything that is complete or near complete and still want to go ahead with off-plan?
Congratulations, you’re made of tough stuff!
Time to consider what safety margins you can put in place:
- Have access to enough funds, locked in and correctly structured upfront to get you through a valuation shock of at least 10 to 15%, preferably 20%.
- Look forward all the way to the sunset clause * date in the contract and take into account any other finance you may need to take out as well as any likely or possible changes to your living costs.
- Taking 2 above into account, make sure that this transaction doesn’t take you anywhere near your maximum borrowing capacity.
- Make sure that your application is acceptable, with a large safety margin, to a number of different lenders. If you only have one option and they change policy on you, you’ll be up that proverbial creek without a paddle.
- Consider how secure your job is, or your ability to replace your income at a similar level in a short space of time.
Having these strategies in place will go some way to you being better placed to deal with how the transaction may play out.
*The date at which you can cancel the contract if it still hasn’t registered, If the contract doesn’t have a Sunset Clause, don’t sign it!
