Buying a home? The traps of the finance clause in a purchase contract.

When signing your contract for purchase of land, home buyers should take care to ensure that the finance figure in the contract is no less that what they will apply to borrow.

If the figure in the contract is too low, the consequences can be extremely serious.  You could find yourself in breach of contract, even though you say you have done everything you could possibly do to obtain finance.

We have seen this situation arise in a couple of ways. You may underestimate the amount you need to borrow for settlement; failing to allow for stamp duty, transfer registration costs or the adjustments to be paid for rates and taxes is one example.

The second can occur when vacant land is being purchased, or an existing dwelling is to be demolished for a new build and you decide to apply for a larger loan to cover the full cost of construction of the new home.

Some lenders will strongly encourage buyers to do this, and may even decline to lend only the amount required to purchase the land, but that does not release the buyer from their contractual obligation to the seller.

Finance clauses (“conditions”) in land contracts specify the amount of the loan for which the buyer must obtain approval.  There are several different standard contract forms in use in South Australia, and the finance clauses differ from one to another, but they all require the buyer to use their “best endeavours” to obtain the loan amount specified in the contract.   Some of these contracts state that the buyer must make an application for a particular amount (or less).

If the buyer tries to obtain finance for a higher amount and fails to do so that may well be a breach of contract. There is a real risk for the buyer if they cannot obtain a finance approval within the required timeframe specified in the contract. As a buyer, you will lose your deposit, and possibly be liable for a loss over and above the amount of the deposit if the seller has to re-sell the property at a price lower than your contract price.

Buyers should remember that it is their decision as to how much they need to borrow and it may well be an amount greater than the contract price. Explaining the difference in the two amounts to the selling agent should illustrate to the agent that the buyer has ‘done their homework’ which should assist with acceptance by the vendor. In these circumstances, the agent and the seller may well be willing to enter into a contract on that basis. If they are not, it is better for the buyer to consider an alternative property than run the risk of understating the amount of finance required in the finance clause.

If a contract is to be signed with a finance clause, we recommend that the buyer obtains advice from a finance broker before entering into a contract to buy.  The finance broker should be able to advise quite accurately how much the buyer is going to need to borrow to secure the property, and often also whether the buyer’s application is likely to be successful.  While this discussion may lead to a reassessment by the buyer of the sale price they should be considering, that is a good not a bad thing.  Better to have had that discussion before you start hunting.