Why is Subject to Finance Important in Australia
Property sales contracts in Australia are typically subject to finance. But, what does this mean? And, do you need it? Many people advise against including finance clauses in the sale contract. However, the condition might save you from being locked into a purchase you cannot afford.
This article will unpack what subject to finance is, when it’s needed, and how to ensure you have it written into your sales contract.
What Does Subject to Finance Mean?
When you put an offer in on a house, your solicitor will draw up a sales contract. At your request, they can include any conditions of sale. These might consist of subject to independent valuation of the property and passing all inspections. The most common clause, however, is the subject to finance condition.
Essentially, this means that the home buyers won’t be legally bound to purchase a property should their loan application fail finance approval. Therefore, if your home loan is refused, you are not obligated to go through with the purchase. You won’t suffer any financial or legal consequences for ending the sales contract either.
Most clauses have a time limit by which time the seller expects the contract to become unconditional. Time frames differ from state to state, ranging from 7 days in the ACT to 28 days in WA. In NSW, the clause lasts typically for two weeks. You are expected to do everything reasonably possible to secure formal approval on your mortgage application during that time.
If you fail to get home loan approval, you risk losing the property. The vendor might choose to sell to another buyer. However, you also are free of the obligation to purchase a property you cannot afford. Typically, the home buyer is expected to give written notice within two business days of the approval date.
If you include finance conditions in your purchase contract, ensure you seek the assistance of a qualified lawyer as the wording can be complex.
Conditional and Unconditional Approval
One of the biggest mistakes buyers make in their home buying process is to mistake conditional approval for unconditional.
When you first apply for a mortgage, the lender will superficially examine your circumstances and offer pre-approval on your loan application. Essentially, this means that the financial institution agrees that you meet their lending requirements in principle. However, this is not formal approval and not a guarantee that you will receive the finances to buy your dream home.
After you have been pre-approved, you will need to supply the property details. The bank will then review your application in more detail. You will have to provide evidence of your financial situation. This might include bank statements, payslips, tax returns, and other documents. As an expat or foreign national, it might take the bank longer than usual to make an informed decision.
Many lenders consider less than 100% of your net income if you earn in a foreign currency to account for fluctuating exchange rates. However, this might make it more challenging to secure unconditional finance approval without the help of an expert mortgage broker.
Once the lender has examined your situation and the evidence reflects what you said in your mortgage application, they will offer formal approval. This means that you can unconditionally proceed with the property purchase.
If you mistake pre-approval for unconditional approval and your application is denied, you risk being locked into the sale contract if you do not have a subject to finance clause. Make sure to never proceed with a property until you have formal approval in writing from the lender.
Advantages of Subject to Finance
The main benefit of the subject to finance clause is flexibility and protection. If for some reason, your loan application is denied, then you’ll save yourself from legal action and financial retribution.
Reasons your application might be denied before unconditional approval include:
- Your financial situation has changed dramatically since the initial application
- You have taken on new debts
- Your credit score has plummeted
- Your loan application did not match the evidence
Therefore, you must maintain complete transparency with your lender and broker. Even the unattractive aspects of your finances should be shared.
Disadvantages of Subject to Finance
Many real estate agents recommend against including finance clauses in the contract of sale. While it is good protection for many homebuyers, it can come with some risks.
Firstly, many home buyers mistakenly think that the contract is automatically cancelled if they cannot obtain finance. They presume they will have their full deposit returned to them. However, this is not how subject to finance works.
The clause usually includes the wording that the purchaser will use their “best endeavours” or take “reasonable steps” to secure the loan. If you do not meet this clause – for example, not trying to reapply for a new loan should your first application be rejected – then the contract might proceed unconditionally despite the clause.
Therefore, you risk defaulting on the purchase. If you breach the contract, you risk being sued. As a result, you must seek the assistance of an expert to help write the clause and ensure you understand your obligations.
Secondly, you should also be careful of strictly following the subject to finance clause’s terms. For instance, you must terminate the contract or request a finance extension if the date stated in the contract approaches. If you do not do so in writing within two days of the approval date, then the vendor may assume that you have waived your right to the clause.
Finally, conditions in the contract of sale can make your purchase application look less appealing. If you’re looking at a competitive property market, you risk losing out on your dream property. Vendors are far more likely to want to sell to those who do not include conditions in the contract as there is less chance of the sale falling through.
It’s essential to consider your personal objectives and situation before deciding whether you should include a subject to finance clause.
Do You Need a Subject to Finance Clause?
The subject to finance clause is a fairly standard inclusion in most contracts, whether at auction or private sales. However, it is not an automatic addition. In most states, you will need to negotiate satisfactory terms of the finance clause with the vendor and your solicitor.
Unless you’re 100% sure about your home loan approval, including the clause despite the risks is usually sensible. The potential of being sued if you cannot secure finance is too great a danger for most people.
It’s even more critical if there is any potential doubt about the property’s valuation condition. When you sign a contract of sale, the lender will conduct an independent valuation to assess the property’s current market value.
If the house is worth less than expected, the lender might not offer the particular product you applied for. Or, they could offer a lower loan amount than the purchase price. Yet, your offer on the house has been accepted. Therefore, you might need to use your funds to purchase real estate.
With the subject to finance clause, you allow yourself a short period to reconsider whether the purchase is right for you.
As an expat, you might find yourself in such a situation. If you live abroad, you may not have the chance to view the property yourself in person and, therefore, have to rely on the asking price to reflect the property’s actual value.
To boost your borrowing power and secure a higher loan amount, you should lower the loan to value ratio as much as possible and maintain a clear credit score.
What Should You Look Out for in a Contract?
Your solicitor will write out your finance condition and fine-tune the wording. Generally speaking, the clause will include the following.
- The name of your lending institution or bank
- The loan amount
- The approval date
It might also include the loan terms and interest rate – although this isn’t a requirement of every real estate agent. It will consist of a line stating that the buyer will take all reasonable steps for obtaining finance. This means providing relevant information, signing documents, and submitting applications.
It will also outline the terms of the finance period. You can usually negotiate a time frame between 7 to 21 days. However, remember that “days” refers to calendar days, not working days. So, 21 days is three weeks, including weekends.
You should also be wary of when you exchange contracts. For example, if you exchange on a Friday afternoon, in all probability, the lender won’t check your loan application until Monday morning. Therefore, you will have lost two days. You must keep the time frames in mind, so you don’t accidentally breach the subject to finance clause.
In addition, if you apply for a mortgage with a different lender than the one stated in the finance clause, you risk breaching the contract. This is why it’s best practice to consult a legal expert to ensure you understand all the terms of the finance condition.
What Is the Difference Between Subject to Finance and Cooling Off Period?
The finance condition and cooling-off period are legal ways to get out of the contract. However, they are quite different aspects of the property contract.
As we’ve explained, the subject to finance condition is the buyers’ option to opt-out of the contract should they not secure finance. The clause is tightly written and requires a careful understanding of the conditions. The vendor will typically ask the buyer to prove that the home loan application was not approved.
On the other hand, the cooling-off period is usually around five days after the contracts are exchanged, in which the buyer can choose to opt-out of the purchase without having to give a reason.
The cooling-off period and finance condition work together. For example, if your cooling off period is three days long and the finance period 14 days, these periods run alongside each other. If the contracts were exchanged on 1st May, then the cooling-off period would end on the 4th May and the finance period on the 15th May.
The cooling-off period doesn’t actually start until the real estate agent has provided you with the cooling-off period statement. This might be after the contract is signed and could take between 48 hours and ten days to come through. To avoid delays, it’s best to arrange inspections as soon as the contract is signed.
What Happens if You Breach the Subject to Finance Clause?
Many risks come with breaching the finance condition. If you have paid the seller a deposit, you will likely have to forfeit that money. Most deposits are around 20% of the property value, so you risk losing a significant amount of money. However, the more concerning issue is that you may be required to continue purchasing the property and get sued for breach of contract.
If they sue you, then you will also be liable to pay for any damages and court costs. If the seller was relying on the sale of the property to pay for the purchase of another one, you might be required to cover their losses. Without the lender approving a loan, you might find yourself facing a significant financial burden.
Therefore, you must ensure you follow the finance condition to the letter and do everything you can to secure unconditional approval from the bank.
How Do You Know If You Have the Subject to Finance Clause?
It’s not enough to rely on your own review of the sale contract. Make sure you deal directly with a qualified lawyer to understand the terms of your contract and whether you’re protected by a subject to finance clause.
The cost of hiring a good solicitor will add additional expenses to your home purchase. However, it could save you a lot of stress should something go wrong. Plus, it could save you high costs in the long run.
How to Secure Finance
So, you know to look out for a finance conditional before entering an unconditional contract. However, how do you ensure that your home loan application is approved?
- Speak to an expert
To optimise your chances of securing home loan approval, you should work with a mortgage broker. Brokers are experts in the mortgage industry and will advise you on which credit provider and credit product best suits your situation. This is especially recommended as an expat as many lenders are wary of foreign income.
Your mortgage broker has a range of connections and can get you a better interest rate and comparison rate on your home loan.
- Improve your credit score
Lenders assess your credit score to judge how reliable you are at repaying debts. If you have a poor credit history, it’s not impossible to get a home loan. However, you might find that your borrowing power is weakened.
A strong credit score will improve your chances of your loan application getting approved quickly.
- Prepare your finances
This means you need to sort out your financial documents ready to share with the lender. If you have everything prepared and ready to go, there will be far less back and forth. This should minimise time wasted throughout the mortgage application process.
You should also ensure that your deposit is ready. The bank bases its loan approval decision mainly on your loan to value ratio (LVR). The LVR is calculated by dividing the loan amount by the purchase price and presenting it as a percentage.
Typically, the bank expects home buyers to have an LVR of 80% or less. However you can secure a home loan with a higher LVR, but you will be required to pay Lender’s Mortgage Insurance.
- Shop around
You mustn’t apply for a home loan with the first bank you see. As an expat or foreign national, very few lenders will approve your loan with favourable terms. Odin Mortgage knows how to find you the best deal for your situation. Therefore, you must seek assistance from a mortgage broker to help you research suitable home loans.
- Stick to your budget
One of the main reasons lenders reject home loan applications is that they do not judge the home buyer can repay the loan amount. Before submitting your application, work out how much you can reasonably afford to repay each month. While you might have the borrowing capacity to get a higher loan amount, will you be able to make each monthly repayment reliably?
Do You Lose Deposit with Subject to Finance?
Subject to finance prevents home buyers from the obligation to go through with the purchase of a property without an approved home loan. If you have already paid the vendor your deposit and need to back out of the contract, you will usually get your deposit back. However, if you breach the subject to finance clause, you will lose your deposit and risk being sued for damages.
How Long Is Subject to Finance?
The subject to finance time frame can range between 7 days and 28 days – calendar days, not business days. The period varies from state to state. You can usually negotiate longer or shorter subject to finance periods with the vendor.
Is Subject to Finance Bad?
Subject to finance protects the buyer from entering into an unconditional contract without a home loan. However, it can also make your offer on the house less attractive to the vendor. If you’re buying property in a competitive area, the seller might accept someone else’s offer if they do not include conditions of sale in the contract.
Is Pre-Approval Still Subject to Finance?
Pre-approval on a home loan is not an unconditional guarantee of securing the finance. If you only have pre-approval, then it’s essential to include the subject to finance clause to protect you should the bank not give unconditional approval.
Can You Buy Land Subject to Finance?
If you’re using a home loan to purchase land, then you can include the finance condition that the purchase is subject to unconditional approval. Then, if your home loan application falls through, you are not required to continue with the purchase.
Can You Buy a House Subject to Finance?
Subject to finance is a standard clause in the sale of contracts on houses. The clause provides time (usually between a week and three weeks) to organise the finances to pay for the purchase of the property.