Finance clauses – debunking some myths

We’ve written extensively about finance clauses, when to use them, when they reduce the strength of the offer, why brokers like to use them as a safety blanket, and when a client is in a higher risk category. 

But there are a lot of myths out there when it comes to finance clauses.

This article will address the top three; 

You can’t have a finance clause on an auction purchase

Auctions in Victoria do not allow for a cooling off period. Ideally the agents, solicitors and vendors want the sale to be unconditional. Most are. But the rules don’t preclude two agreeing parties inserting a condition into the contract; we do it all the time. 

It is unusual that an agent would allow a buyer to bid at the Vendor’s reserve price with a finance clause in place, but it’s not impossible. If the vendor and their solicitor agree to permit it, the Buyer may just get their chance to bid. In nine years I’ve bid under the hammer with a finance clause three times. It tends to occur in bear markets like the one we are currently in. When an agent would rather have certainty of bidders, albeit finance-clause bidders, they may just say yes.

In many situations I’ve negotiated a pass-in bid with a finance clause, particularly of late.

Just because your finance pre-approval isn’t finalised doesn’t mean you can’t bid at auction. Just be clear with the agent that you can’t buy unconditionally under the hammer, because if you aren’t clear and the property is placed on the market, you may just be buying unconditionally. It’s not a tactic to be cavalier about. Communication and transparency in this situation is King.

If you don’t obtain finance in time and wish to exit the contract, you can do so and no questions are asked

The law provisions for both parties (Vendor and Purchaser) fulfilling their obligations under this clause. If the loan is not approved by the approval date or any later date allowed by the Vendor, the Purchaser’s deposit must be immediately refunded and the contact ended. 

However, in the Sale of Land Act, General Condition 14.2(b) states that the Purchaser must do everything reasonably required to obtain approval of the loan.

This means that delaying or doing nothing is not an adequate reason to exit the contract.

There have been many precedent cases where this clause has not prevailed for the Purchaser. A buyer who chooses to rely on this ‘out’ should expect some rigorous debate from the Vendor’s solicitor, including a request or the decline letter and proof of demonstrable and timely efforts to obtain the finance.

You don’t need a finance clause if your pre-approval is granted by the lender

This is the most critical of all three myths.

There are different types of pre-approvals and they all offer varying degrees of assurance;

1. The old chestnut, “my banker/broker says I should be fine”.
   Terrible idea. Always seek a proper approval with credit-assessment of all of your documentation.
2. Online, automated “indicative” pre-approval.
   Another terrible idea. The algorithm is not a bank loan assessor and it can’t verify what you input, even if you are trying to represent yourself honestly.
3. Non-credit-assessed pre-approval.
   Another dangerous idea. Some lenders are doing it, including Nab. Do not rely on something that has not been credit-assessed. Ask if in doubt.
4. Credit-assessed pre-approval with conditions. 
   Check the conditions. If any relate to something you think you can’t fulfil, check with the bank before you buy. 
5. Credit-assessed pre-approval with only two conditions: subject to the security property being acceptable to the bank, and subject to bank valuation. 
   These two conditions apply to most pre-approvals and are generally easy to manage if you know what banks don’t like, and you have confidently tackled the recent comparable sales analyses.

In any of the cases 1-3, we’d strongly recommend a finance clause or further effort with your pre-approval confidence.

In the cases 4-5, it’s essential to be familiar with the types of properties that banks could have concerns about, including high-rise, any quirky zones, any damaged or very run-down properties, among others.

Importantly, if the loan amount as a percentage of the purchase price is high (above 80% is moderate risk and above 90% is high risk), a finance clause could give comfort to a borrower who could not financially bridge the gap in the unlikely event of a valuation shortfall. A lovely client’s recent purchase in Geelong West (above) included such a clause and her formal approval was granted just a few days later.

And likewise, if the property is off the plan and/or subject to the plan of registration being finalised in the Titles Office, buyers must anticipate delays beyond their typical three month pre-approval timeframe. If buyers have any doubt about their future chances of getting the same pre-approval for such a purchase they should proceed with high caution. 

If a settlement delay for an unregistered title (ie. off the plan), pushes past the three month period and the pre-approval is no longer active (or able to be reactivated), the buyer will find themselves in hot water if they can’t finance the purchase.

Pre-approval can weaken an offer, but if the absence of a finance-clause spells trouble, buyers should include the clause and find an alternative way to strengthen the offer.