Great news! Your new build home has reached practical completion and the code of compliance certificate has been requested from the local council. You’re now just weeks away from being able to settle. But as you start working through the pre-settlement paperwork you come to the agonising realisation that the finances no longer line up, putting your ability to settle and take possession in jeopardy.
While not a common scenario – it is one that we’re currently seeing more of thanks to the current economic turmoil.
Because when you buy a new build property, there’s often (though not always) a lag between when you go unconditional on the property, and when you settle and take possession. And this period could last anywhere between a few months, to well over a year depending on when in the building process you purchased.
In most cases this is fine, but it does open the process up to a few risks which could impede your ability to settle when the time comes.
But forewarned is forearmed, and with a little bit of planning these risks can be navigated so you can settle on your investment property as planned.
So, what are the financial risks associated with a longer settlement, and what can you do to mitigate them? We outline the 3 main scenarios below.
Scenario 1 – Your situation has changed
When there’s a long gap between signing and settlement, there’s plenty of time for your situation to change in a way that could impact how much the bank is willing to lend. For example, this could be a reduction in your income, which then limits how much the bank is willing to lend based on their assessment of your ability to service the loan.
If your situation has changed, you’ll want to do what you can to prove to the bank that you’re able to service the loan or find a bank that’s willing to loan you the money based on your current financial situation.
Scenario 2 – The bank’s lending rules change
In some instances, it won’t be your situation that’s changed, but rather that of the world around you – like a rising Official Cash Rate. This in turn changes how banks test borrowers on their ability to service a mortgage – often by increasing their testing rates.
Where a year ago, they may have tested you at 4%, they now test you at 8% – which can have a significant impact on how much they’ll allow you to borrow based on your surplus cash flow.
If you have a pre-approval and changes are slight, the bank may still honour the deal.
But if not, you’ll want to find ways to improve your position in the eyes of the bank. This could include reducing ongoing costs – like closing credit cards and lowering your KiwiSaver contributions. Or, if you have extra funds available to put towards the property, this can help lower the amount you borrow (so there’s less to pay back).
You could also look to a different bank, or a second-tier lender, that might have lower testing rates or use different criteria to determine your ability to service the loan.
Scenario 3 – The value of the property is now less than the purchase price
There is also the risk that the property value (on paper at least) could drop lower than the price you’re having to pay for it.
While not all banks will require a valuation to disperse the funds, if they do and the valuation comes in less than the price you’re having to pay for the property, this could impact your ability to get enough money from the bank. As they’ll be lending 80% of the value of the property, not the purchase price, this would leave a gap you’ll now have to fill.
If this is the case you may be able to negotiate with the bank to see if they would be willing to lend you more than the 80% they originally were going to. Getting another valuation may also be an option if you feel the first one undervalued the property.
You may also find you have enough equity in another property you could use to put towards the deposit or other savings that you could use to bridge the shortfall.
What if you’re really not in a position to settle?
But what happens if you end up in a position where you really just can’t settle? Often there will be a legal obligation to settle, and reneging on that contract can come with some hefty costs. You’ll potentially lose your deposit and there may be legal fees associated with breaking the agreement.
But that doesn’t mean all is lost if you do find yourself in a position where you just can’t (or really don’t want to) settle.
You may be able to negotiate with the vendor for a solution that suits you both. Or make arrangements to on-sell the property through a contemporaneous settlement. Or even settle on the property and sell it later down the track.
The decision on whether you pull out all the stops to settle will depend on your situation and the problem for which you’re trying to solve.
Pulling out of settling an investment property may – for some people – significantly reduce the time they have to prepare for their retirement. Not settling could set them back several years and means they may not end up with as much money during their retirement as they had planned.
It’s also good to keep in mind that some of the impacts – like higher top-ups for the mortgage – are likely to be temporary as the property market moves through its cycle. When mortgage rates come back down, so will these costs which will ease that additional impact on your cash flow.
What if you’ve just bought a new-build property?
If you’ve just gone unconditional on your new build property, and know you have some time before settlement, now’s the time you make sure you’re in the best financial position when settlement comes, so you don’t find yourself in one of the above scenarios.
Continue to look at ways you can improve your cash-flow surplus and build a buffer to offset any changes – either as part of the deposit or mortgage payments. It may also be appropriate to renew your pre-approval from the bank as it lapses (about every three months), so you have a little extra reassurance that the bank will lend that money when it comes time to settle.
If you’re on the road to settling soon and are a little worried about how the current economic conditions will impact your ability to take possession of your property, we highly recommend talking to a financial adviser. They’ll be able to assess your current financial situation, model how you could work through the various scenarios above, and put a plan in place so you can settle with confidence when the time comes.
Disclaimers: This blog post is for informational purposes only and does not constitute individual financial advice. If you’re interested in receiving personalised financial advice, you can book a consultation with an enable.me coach. Costs apply.