Over the past 12 months, you have probably read and heard about the hot property market, with unprecedented auction clearance rates and large increases in prices. This can lead to some problems if you have bought a property and you intended to borrow the money from the bank to fund the purchase.
We have heard of the following scenario a number of times recently and it means you have to be very careful you do not over extend yourself and open yourself up to the risk of being unable to settle on the property.
You find an investment apartment in Sydney for say, $1.2M, and you have been successful at auction in securing it. You did the right thing and got interim approval for the borrowings to meet the intended purchase price. Like most property purchasers you got caught up in the moment and bid a little bit more than you were willing to pay. Your limit on the property was supposed to be $1.15M. Never mind, you think, you can always find the extra $50k from somewhere!
You now go to the bank to take the next step and expect that they will lend you 80% of the property’s purchase price ($960k) and you then have to find the balance of $240k, plus stamp duty of $51,490. In the process of organising the borrowings the bank sends a valuer out to the property to value the property for the bank. This is where the problems start. Valuers are providing an opinion to the bank on the value of the property and are going to be very conservative in the value they provide. If they value it too high and, in the future, you can’t meet repayments on the loan and the bank has to take possession of the property and sell it, then the bank will want to be sure that they at least get their money back. If it is valued too high there is a risk of the bank losing their money. If this happens, then the bank will likely take legal action against the valuer for the loss they have suffered due to the valuation being too high.
No valuer wants to have that risk, so the easiest way to avoid it is to value the property on a very conservative basis and ignore what has been actually paid for the property. The valuer, especially in an overheated property market like we currently have, will assume that the market will come off at some stage soon and they will not be afraid to value the property at less than what has been paid for it. This is the case even though the property has found its, so called, market price in a public auction.
In our example above, say the valuer values the property at $1.08M (a 10% decrease). All of a sudden you have to find the shortfall of $120k from somewhere else. You might have another property with some equity in it where you could use the security to meet the shortfall. If you don’t have another option then you have a real risk that you won’t be able to settle on the property. The risk here is that you miss out on the property, lose your deposit and could have action taken against you for any loss the vendor bears by having to sell the property later (and maybe in a cooler market) to another buyer for less than the $1.2M that they had secured from you.
The moral to the story when it comes to property in this market is:
- Do your figures and know what you can afford
- Be conservative as to what you can afford and factor in that the bank may not value the property at the same price you pay
- Have a contingency plan where you can access extra funds or extra security to easily and cost effectively manage the settlement
Feel free to contact us if you have a specific scenario you would like to discuss.