When buying a property, don't always bank on the banks making it easy
Clearing some of the obstacles the banks put up can cause many an unwary property buyer to stumble but there are ways to crawl through the loan process without getting hurt.
Many buyers naively expect that a pre-approved loan automatically signals a guarantee of bank funding when it comes to making a new property purchase.
There are, however, almost always conditions associated with a lender’s pre-approval.
For those buyers who provide documentation for full credit assessment, even their pre-approvals are likely to be constrained by some important conditions.
A close perusal of the pre-approval letter will likely reveal that lending is contingent on at least two things.
The valuation conundrum
Firstly, the ‘security property’ (i.e. the property that the debt will be secured against) will need to be valued by the bank at a price that matches or exceeds the purchase price.
Valuation shortfalls don’t necessarily spell the end of the world, but in situations where the bank valuation is below the purchase price, a purchaser may have to adjust their loan to value ratio (LVR), or they could be required to contribute a higher deposit.
Either way, it means that they need to either find more cash or potentially pay an insurance premium for lenders mortgage insurance (LMI). Both are recoverable in most circumstances, but often stressful.
As difficult as that may sound, however, it’s the second condition that is sometimes hard to resolve.
The bank controls the goalposts
The second criterion is that the security property must meet the lender’s criteria.
It is this second condition that can unravel the best laid plans. What does it mean? And what are the bank’s criteria?
It is more a case of knowing what isn’t matching the bank’s criteria. Experience as a mortgage broker prior to working as a buyer’s agent has proven very useful for me. I avoid buying properties that the banks don’t like.
Let’s start first and foremost with zoning. A residential loan pre-approval means just that. You are buying a residential property.
When the zoning suggests otherwise, issues can strike. I have seen plenty of apartments in commercially zoned buildings face lender scrutiny.
While some lenders may wave the apartment through, many do not.
The implication of a purchase like this could be a commercial loan product.
Commercial loans attract higher loan rates and require a more significant deposit, (typically 35-40 per cent).
In addition, they are amortised over a much shorter loan term of 15 years (concerning a loan, amortisation focuses on spreading out loan payments over time).
The impact of this heightened repayment on borrowing capacity is significant, and for buyers who still have the 40 per cent deposit on hand, they may find that they do not service the loan anyway.
The same principle stands for industrial zoning.
One key dwelling type to look out for includes trendy warehouse conversions.
Many have been rezoned to mixed use, but plenty of buyers can get caught out with industrial zoning.
The worst-case scenario for a buyer who finds themselves in this unfortunate position is loss of deposit and potential legal action if the vendor chooses to pursue any losses.
Commercially zoned apartments are cheaper than residentially zoned apartments for a reason. They are harder to buy and harder to sell. The buyer pool is reduced.
More bank hurdles
A damaged property is another important consideration.
Fire or flood damage, or even a semi-gutted house is a red flag for a lender.
Some lenders will wave a damaged property through as “land only”, hence reducing the percentage of lending for which they’ll cover a buyer.
On that same theme, lenders will apply postcode restrictions to certain, higher-risk areas. Flood prone areas, bushfire impacted areas, and over-supplied high-rise areas are often avoided or penalised by lenders and/or mortgage insurers.
An unusual, and sometimes unpredictable reason for a lender to refuse a security property relates to their own exposure to a building. For example, if a high rise, off-the-plan building is about to title, (i.e. the building is complete, strata subdivisions are through and the units are ready to settle), a lender may suddenly advise that their exposure to the building has hit its risk-threshold.
It could be an arbitrary percentage that the lender has deemed a sensible limit, and the buyer suddenly finds themselves the 51st buyer, asking the lender with a 50-apartment limit for credit. In the case of an off-the-plan purchase, (which already carries a greater degree of risk), it is highly advisable for a buyer to have a plan B option when it comes to lenders.
Buildings with safety-related defects can often be rejected by a lender. Combustible cladding, structural defects, and council orders can all signal lender issues.
Navigating a purchase without loan approval guaranteed
So, how do buyers navigate a purchase knowing that their loan approval is not guaranteed? It’s important to remember that most bidders who buy at auction face these same constraints.
Obtaining a thorough legal review of the contract, chatting openly with your broker about any red flags you identify with the property, and doing pricing research by way of comparable sales analysis can help set you up for success.
Reverting to private sale negotiations with finance clauses can provide peace of mind but it also rules out some good properties that are schedule for auction.
To compound this, a finance clause can disadvantage a buyer in the negotiation when fighting it out with other, unconditional buyers.
Ultimately, investing in any asset class carries risk, and it’s how we go about managing and mitigating this risk.
Knowledge is power, and applying due diligence and rigour can make the difference between a stressful purchase and a successful one.
