You’ve found the right property and finally settled on a price with the seller. What else do you have to do before you can close the deal and collect the keys to the property? Paul Do walks you through the process.
A first homebuyer recently faced the following problem. She inspected a unit and fell in love with it at first sight. She negotiated hard, settled on a price with the vendor, and then went to the agent’s office to sign the contract. The next day the agent called her and said that he had received a higher offer and that he may have to take the higher offer if the other buyer managed to sign the contract that day. He asked her if she could increase her offer or waive the cooling-off period. What would you do?
Well, I definitely wouldn’t waive the cooling-off period if I hadn’t carried out the required inspections. And I would think twice about increasing my offer. Here’s why.
After you agree on a price with the seller, there are four more steps before you can close the deal. This is shown graphically in ‘Steps to settlement’:
1. Holding deposit
2. Exchange of contracts
Step 2 is by far the most important and complex. All four steps apply in each state and territory, but the details are quite different, so make sure you check with your solicitor or conveyancer for the specific details in your state/territory before doing anything.
1. Holding deposit
In a private treaty sale, after the seller accepts your offer, the agent will usually ask you to pay a holding deposit of a few hundred dollars to show that you are serious about the purchase. The holding deposit serves no other purpose, and most importantly, does not secure the property. The property remains on the market until contracts have been exchanged in step 2. If you haven’t already shown your solicitor or convenyancer the contract, then now is a good time. Some people also carry out a building and pest inspection and get unconditional approval from their lender during this step.
The advantage of a holding deposit is that if either you or the seller changes your mind, the holding deposit is fully refundable. The disadvantage is that before exchange (see step 2), the agreement is just verbal and not binding, so the seller can gazump you. Gazumping occurs when the seller verbally agrees to sell the property to you, but then sells the property to another party on more favourable terms. You will lose any money spent on legal fees, loan application costs and building and pest inspection costs, not to mention the time to find another property. And you will have to start again.
Although our first homebuyer had already signed the contract, the vendor had not exchanged contracts, and so the agent was threatening to gazump her.
2. Exchange of contracts
In this step, you and the seller each sign a copy of the contract of sale and then exchange these documents to enter a legally binding contract. You secure the property and ‘close the deal’ by signing the contract and paying a deposit. There are two types of exchanges. Under a conditional exchange, a deposit of 0.25% to 10% of the purchase price is payable. In most states, you have a five-day cooling-off period to rescind the contract if you decide not to proceed with the purchase, but at a penalty of 0.25% of the purchase price. This works out to be $250 for every $100,000, or $1,250 for a $500,000 property. If you want to rescind the contract you must do it in writing. And you will have to start again.
The advantage of a cooling-off exchange over a holding deposit is that it locks the seller in. The disadvantage is that it costs a lot of money to rescind the contract if you change your mind, or the building or pest inspection is unfavourable or your finance is not approved. The cooling-off period is used to conduct the building and pest inspection (usually ordered by your solicitor or conveyancer) and get unconditional loan approval. The pre-purchase loan approval is conditional on satisfactory valuation of the property, so the lender will have to get a valuation done during this time. If your solicitor or conveyancer has not seen the contract, this is the time when they go through it to check for any irregularities and do various searches. You might have to ask for a few days’ extension of the cooling-off period to get everything completed.
Under an unconditional exchange, such as with a pre-auction offer, you give the seller a section 66W certificate in New South Wales or a lawyer’s certificate in Queensland, the Northern Territory and the ACT waiving the cooling-off period, and pay the 10% deposit. In Victoria and South Australia, you waive the cooling-off period by obtaining legal advice. The contract cannot be rescinded.
Both the holding deposit and exchange of contracts steps involve trade-offs. A holding deposit does not result in any loss if you change your mind (provided you don’t incur any costs), but the sale is not guaranteed, while if you exchange contracts, you will incur a penalty if you change your mind, but the seller cannot withdraw from the sale.
You can’t have it both ways. So what should you do? Well, it depends on the market conditions. Paying a holding deposit in a rising market doesn’t make much sense because you will be much more likely to be gazumped. If that occurs, you could end up being caught in a spiral of rising prices. In addition, if you think you are getting a good deal, then you should try to exchange contracts as soon as possible because you are competing against other buyers who might be prepared to pay a little bit more to secure the property. In these two situations, some buyers don’t bother with a holding deposit and exchange contracts right away.
Our first homebuyer had not conducted her inspections, so she said ‘No way!’ to waiving the cooling-off period. She also decided to call the agent’s bluff and held firm with her offer. Later in the afternoon, the agent called and said that the owner had decided to accept the offer and came in the next morning to sign the contract.
Conveyancing is the legal transfer of the property from the seller to the buyer. You might be tempted to do it yourself, but most people use either a solicitor or a conveyancer, who have professional indemnity insurance for your protection. The typical conveyancing cost is around $1,000 including disbursements, which covers examining and exchanging the contract of sale, organising building and pest inspections and conducting various checks.
If you haven’t already done so, you should conduct a building and pest inspection (and a strata inspection for apartments) which cost a few hundred dollars each.
A building inspection is a visual examination of the accessible areas of the building to determine its condition and look for structural defects.
A pest inspection is a visual and auditory examination of accessible wood structures in the building for wood-destroying insects such as termites and decay.
A building and pest inspection are part of the cost of investing in real estate. Nearly everyone who is not a mechanic would get a mechanical inspection before buying a used car. Yet many people try to save a few hundred dollars and skimp on a building and pest inspection when they purchase a property that costs many times more. This is false economy, because it could cost tens of thousands of dollars to rectify structural and pest damage.
After the vendor exchanged contracts, our first homebuyer’s solicitor began to organise a strata report. In the mean time, she became suspicious of the agent’s shenanigans and decided to Google the apartment building. She found out from a forum that the strata levy for the building early last year was $2,800 per quarter compared to $680 at the moment and that the building has a list of structural problems.
When the strata report was ready the solicitor only had bad news. There were a number of problems including a significant conflict of interest between the apartment owners and the developer, a long list of structural problems that are likely to be permanent and a list of outstanding items that needed to be fixed in the building.
The next day our first homebuyer rescinded the contract and lost her $900 deposit. It was then that she realised why the agent was trying to pressure her into waiving the cooling-off period.
Unconditional loan approval
The lender’s valuer will require access to the property during the cooling-off period to conduct a valuation of the property for unconditional approval.
Pay the balance of deposit, or rescind
At the end of the cooling-off period, usually the inspections are all in order and your loan application is unconditionally approved, and you proceed to the next step by paying the balance of the 10% deposit.
The deposit is held in a trust until settlement, with the interest split between yourself and the seller. If you fail to complete the contract after the cooling-off period, you forfeit the 10% deposit and might even be liable for any losses suffered by the vendor above this amount.
However, sometimes the inspections are unfavourable or your loan application is declined or you change your mind. You can elect to rescind the contract by forfeiting the 0.25% deposit.
Settlement normally occurs 30 to 90 days after exchange of contracts (not the date of the expiry of the cooling-off period). At settlement, you pay the balance of the purchase price to take ownership of the property. The final amount includes adjustments for water and council rates. The lender retains the certificate of title until the mortgage is repaid. You should arrange a final inspection with the agent to ensure that the property is in the same condition as it was when purchased and that the vendor has left all of the inclusions in the contract with the property.
Paul Do is the author of I Buy Houses: The Property Investor’s Handbook.