Information for Future House Buyers
If you are someone who is intending to buy a house in the future, but you are still saving up to be able to do so, there is only one Chapter in my book that is of relevance to you at present.
That Chapter gives you information about when you will have to pay out money for a house bought at auction, how to save money for a deposit, and how to prepare for applying for a home loan.
Because it would be unreasonable to expect you to buy the book to be able to read that Chapter, I have put an edited copy of that Chapter here:
Make sure you’ve got the money available
To be ready to go to an auction to buy a house you need to have made sure that:
on the day of the auction you can give the agent a 10% deposit of the purchase price of the house; and
on the day of settlement, you can hand over the other 90% of the purchase price of the house.
If you will have to organise finance through a financial institution to be able to buy a house, there are some things that it would be useful for you to know well before you are ready to actually buy a house. In fact, knowing these things might put you in a position to buy sooner than you otherwise might.
Don’t bid if you don’t know where the money is coming from
First and foremost, I very very strongly recommend that you do not bid at an auction unless you know that you will be able to pay the deposit and the balance of the purchase price.
By “know”, I mean know that you have the money, or know where it will come from. Like: from X Bank, because you have a pre-approval from that bank. Not like: from “a bank (I hope)”.
By the way, in a recent on-line survey of 1,000 intending first home buyers, 78% of them did not appear to be aware that it was necessary to pay a 10% deposit on the auction day if they were successful at auction. Please be aware that it is so – it is part of the contract that applies to those bidding at the auction , and it is almost universal at auctions . I note that there is no reason why you can’t ask to pay a lower amount as a deposit, but that that is something you need to organise before the auction.
Few people have cheque books these days, so usually agents are happy for the deposit to be transferred electronically by the next business day (various people I know have been able to have this extended to as much as 3 business days), provided that you can deposit at least some money with them on the day – usually something along the lines of $1,000 in cash will definitely do the trick.
But, one way or the other, you will have to have that 10% in the agent’s account very soon after the auction. If not, you will lose the house, plus you face the prospect of very messy legal action being taken against you, as you will be potentially liable for any additional selling costs that the seller might incur in selling to someone else. I also remind you that there is no such thing as a cooling-off period with respect to auctions.
Why do you need to know ?
If you do not follow this advice with respect to the balance of the purchase price, you open yourself up to a period of potentially enormous stress and hassle. I note that if you do not come up with this balance on the settlement day you will lose your deposit. Against that background, and assuming that you can get finance, you may well be forced to accept an offer for finance that will cost you a lot more than if you had organised it before you bought the house. And that cost will be an on-going cost, not just a one-off.
In a nutshell, the chief concern of lenders in lending you money is your capacity to repay the loan. They will take considerable time and trouble to assess that capacity. That is the first problem: you can’t be sure how long a lender will take to assess your application. And lenders work to their own timelines, not yours.
I also note that if you are going to lend more than 80% of the purchase price, you will almost certainly need lenders mortgage insurance. Approval for that insurance will need to come from the insurance company, not the lender. So that can also take time.
And if you have any doubt about what might be involved in making a loan application and how long it might take, have a quick read of the next section to get an idea of what you will be in for when you apply for a home loan.
There are lenders who may be prepared to take more risks with respect to your capacity to repay. However, as with everything else in life, lenders will not take on more risk for free – there has to be something in it for them. And that something is higher fees and higher interest rates.
The second problem of loan applications is that no lender has to give you a loan. It’s not their problem if they refuse you a loan. The consequences to you of a refusal are of zero concern to them.
The third problem with respect to home loans is that until you have your approval, you can’t be certain how much you will be allowed to borrow. Every case is unique, so just because someone you know who earns about the same as you got a loan of X amount, that tells you nothing, even in the unlikely event that you also know what other assets that someone has, and what their spending habits are.
I note that most financial institutions call the process of getting an assurance that they will provide you with a certain amount of money to help you purchase a house the getting of a “pre-approval”. Unfortunately the period for which pre-approvals are valid seems to be shrinking over time.
I am well aware that it can be quite a hassle to organise finance in relation to something that you don’t end up getting, but I can assure that that hassle will be nothing compared to the hassle you might have to go through if you have to try to organise finance after you have bought a house.
Be very conscious of this if you are confronted with an opportunity to buy a house before you have sorted out how you will finance the purchase.
And, despite what I have just said about pre-approvals, they are usually valid for a few months at least. Hopefully in the time that a pre-approval is valid you can find another house if you don’t get the first house that you find.
Loan application preparation tips
I think it might be useful to give you at least a little bit of advice about getting a home loan. However, what I am about to say won’t be of much use to you unless it will be a while before you are intending to seek a loan. In fact these tips emphasize how difficult getting a home loan can be if you only have a short time available.
First loans are the toughest - practice “repayments”
If you have not had a home loan before, you will find it pretty hard going to get a home loan, as the lender will have little history to go on as to how well you can cope with making home loan repayments.
Therefore, in that regard you should start, as soon as possible, setting aside in a special account (the account you use to save for your deposit is ideal for this) at least the monthly amount that you could expect to have to pay to the lender if you got a loan of the size you think you will need. Obviously the longer you have been doing this by the time you seek your loan, the better. And, of course, this tip is redundant if you have been saving steadily for your deposit, unless the monthly amounts you have been saving are less than the monthly amount of your likely repayments.
And, of course, practising making repayments will have the incidental benefit of increasing the size of your deposit. The bigger the deposit you have when you come to buy a house, the better, both in terms of being able to get a loan, and in terms of not needing to lend as much.
And, as I have previously mentioned, if you are going to need to borrow more than 80% of the cost of the house, you will almost certainly need lenders mortgage insurance. The cost of that insurance can be reduced by a number of factors. One of those factors is if you have shown an ability to save money.
You will find it difficult to suddenly start putting a fair chunk of your income aside each month unless you do it as part of a well-worked out plan. That applies even more so if you are part of a household. Who has to sacrifice what?
A more common way of describing a plan to spend and save money is “a budget”. One could easily write a whole book on budgeting. In fact lots of people way more knowledgeable than me on that subject have already done that.
If this is something that you know nothing about, then rather than you having to research what book to buy, I can provide you with a very useful shortcut. There is daylight between the best book on budgeting, and the next best book.
You will do yourself a very big favour if you buy yourself a copy of The barefoot investor by Scott Pape , and then read it, of course. The front of the book states that it is “The only money guide you’ll ever need”. That is a very accurate description. It shows you how to budget in a way that is simple, robust and fun. It recognises that you can’t spend 30 years eating tinned spaghetti while you pay off your home loan – it, in fact, requires you to splurge on anything you want every once in a while. Start reading, and you will soon become, to your lasting benefit, a member of the biggest finance cult in Australia.
And again, it’s not going to hurt when you come to apply for a home loan if you can show that you have your personal finances well organised.
“Tidy up” your discretionary spending
Given how important your normal spending is when a lender looks at your capacity to repay a loan, you might also want to consider limiting your discretionary spending as much as possible well before you seek a loan. I believe the main banks look very closely at your spending and other financial activities in the 3 months before you apply for a loan.
Not surprisingly, if you appear to spend a lot on cigarettes, alcohol, expensive clothes, excess data usage charges, excess phone use charges, gambling, restaurants or takeaway food, you might have some explaining to do as to how this sort of spending will not have an impact on your capacity to meet your loan repayments.
(I note that cutting back on these things will also make it much easier to make your “practice” repayments.)
(I make no comment on whether or not cutting back on these things might also have other benefits – that’s for a different Guide.)
Keep records of your spending
You should also be aware that lenders will want to see a very detailed breakdown of your spending, so you should make sure that you keep all records you have of your spending, and that you keep them reasonably handy. So, don’t throw away any statements, bills or receipts. Yep, that means that once you have cut off the petrol discount coupon from your supermarket receipt, make sure that the receipt itself goes into the box (or whatever you are using to store your records).
Explain everything in a covering letter
Finally, a big bank’s credit assessor’s first impression of a loan applicant plays a very important part in the applicant’s overall chances of getting a loan. In that respect you would be well advised to write a covering letter to go with your loan application. In that letter you should explain anything in the documents that you are sending with the application that might cause the assessor to scratch her or his head. Things like a missed payment on a bill of any sort, gaps in your work history, unusual substantial purchases, or components of your income that are not stable.
Re-financing is easier, but harder than it used to be
I note that if you are re-financing a home loan, although the process will be easier than if you hadn’t previously had a home loan, you will find that it will not be as easy as it was when you got your original home loan. As a result of the recent Banking Royal Commission, all lenders have had to tighten (that is, make more difficult) their loan application processes.
And not only their processes. As a further result of the changes caused by the Royal Commission, lenders these days are also not lending as much as they used to, even if they approve a loan. You would, therefore, if you are re-financing a loan, be very unwise to presume that you can get the same size loan even if nothing substantial has changed in relation to your circumstances.
Lenders mortgage insurance
I am including this subsection because I am aware that many people are unaware of what this is. It is insurance that protects your lender if your loan goes pear-shaped. Thus, it is insurance for the benefit of the lender (and it will be organised by the lender – it is not something you need to organise, but it will require you to give information to the insurer). It is something that you, the borrower, will have to pay for if your loan is for more than 80% of the purchase cost of your house .
The way it usually works is that the insurer works out the premium that is payable for the insurance. The premium is a one-off amount, and it can be many thousands of dollars. You will usually be allowed to add the amount of the premium to your loan. Of course that means that the amount of your monthly loan repayments will be increased to take account of the increased total amount that you need to pay off.
“Tidy up” your credit cards
Although having a credit card and a record of making on-time payments gives you a financial history that is of some benefit when you apply for a loan, it is very much a two-edged sword.
First, if you have had to rely on credit (as opposed to using the credit-free days on a card) at any time in the recent past, your chances of showing that you can support a home loan are very small unless something remarkable (and positive) has happened to your income in the meantime.
Second, you need to be aware that lenders will pay very close attention to your access to credit when they assess your financial situation. Most lenders now will add up the amount of the credit limit of every credit card you hold, and will assume that you will have to pay as a monthly expense the minimum monthly repayment needed to service the combined total of those limits.
From my reading of the state of play these days, it is very much a positive when you apply for a home loan if you do not have a credit card.
Therefore, well before you seek a loan it will be well worth your while to examine whether you need all of the credit cards that you might hold. I know that credit cards are virtually essential for some things these days, but it is worth researching whether you can get by with a debit card for those things. The usability of debit cards appears to be increasing steadily.
If you do need a credit card, it is also worthwhile looking at your limit on the card. Clearly the lower the limit, the better off you will be with respect to your home loan application, and how much you will be able to lend.
Survey by ME Bank conducted in May 2018 (https://www.mebank.com.au/)
If you find yourself bidding unexpectedly at an auction and don’t have the means on the spot to pay the 10%, you may be able to negotiate with the agent to pay the deposit later, but it is essential that you have that conversation with the agent before the auction starts.
John Wiley & Sons Australia, 2017. It is also available as an e-book.
I am not suggesting that your lender will necessarily want to see these, but they will help you work out where your money has been going when you are trying to compile your spending history for the loan application.