Today I will explore the step-by-step process of purchasing a residential property, either for you to live in or for investment.
For a first time property buyer, this is an exciting and scary activity at the same time. It is a long process and you probably do not know what will happen next and what you are meant to do. I hope this guide will get rid of some of your nerves because it outlines exactly what will happen.
For the seasoned property investors, you probably have your own ideas of what works best for you. The sequence of steps outlined below is not the only way, and it may not be the best way. But the below steps worked well for me when I was starting out.
This is a long guide intended to be read slowly over the weekend.
Look at Properties Online
The first step is to take an initial look at property listings websites, such as www.realestate.com.au and www.domain.com.au, to find what’s “out there”. I personally prefer www.realestate.com.au, as it tends to have slightly more listings in the suburbs I am interested in.
If you are investing, www.realestate.com.au also has an “Invest” section (www.realestate.com.au/invest) where you can see the top performing suburbs, based on either annual price growth or rental yield (cash flow), as well as the average 5-year annual growth for a particular suburb you are interested in, for a particular type of property (for example, you can filter based on 2-bedroom units only). Also important is to look at the number of property sales and rentals reflected in the data. A suburb may have a stunning 30% annual growth, however you may not achieve this growth if the figure was based on only 10 home sales, or if there have been plenty of new developments which naturally have higher prices compared to the existing older properties.
If you are buying to live in, you can still consider the above statistics. My personal philosophy is to purchase a home with good growth potential, even if I will be living there. I will start off with a pool of suburbs and properties with decent growth potential. I will save/bookmark those properties on www.realestate.com.au, then narrow down my choice based on whether I personally like the floor plan, aspect (north and east are typically good), distance to work, public transport and amenities such as shopping centre, restaurants and cafes (or you might want to be close to a good public school or hospital depending on the stage of your life). Based on these considerations, I will start to un-save/un-bookmark those properties I do not like.
The same principles can be applied when buying for investment, however you will want to focus on “what most tenants like” in the area, instead of what you like personally. More amenities are generally better even though they may not be relevant to you. Domain has a suburb profile which I found quite helpful to get an insight to the demographics in the area (www.domain.com.au/suburb-profile).
Get a Home Loan Pre-Approval
By now, you have looked at a few properties you like, online, and possibly in person too. But can you afford them? A mortgage broker can do a quick analysis of your borrowing power with various lenders. Generally speaking, if your income is from a permanent full-time job, which only pays you a base salary, without overtime, bonus or commissions, it is very easy to work out how much you can borrow and you will get a similar answer from let’s say the top 10 banks in Australia. However you receive overtime, bonus, commissions, or perhaps different types of payments from Centrelink, business income, rental income or overseas income, there will be noticeable discrepancies in your borrowing capacity, depending on which lender you go to. This is because those other income sources are typically not counted in full, as they are considered to be less stable than a base salary set in stone in your employment contract.
Different lenders apply different percentage factors to different sources of income (for example, a particular lender may count 80% of commissions and 75% of rental income). They also have different policies about how to calculate it (for example, a particular lender may average your commissions over the last 6 months before multiplying it by 80%, whereas another lender may average your commissions over the last 2 years). Therefore it is quite important to see a mortgage broker, or see a few different lenders (banks or non-banks) if you prefer to do it yourself.
At the time of writing, a single person earning $50,000 annual salary can generally borrow around $300,000 for a property to live in if they have no debts or credit cards; or potentially around $450,000 if it is for investment and they are still living with parents rent-free (because there will be rental income in addition to salary). A couple each earning $50,000 annual salary can generally borrow around $600,000 for a property to live in; or potentially around $900,000 if it is for investment.
At this stage you want to think about the properties you looked at online previously. Can you afford the property you wanted? If you are aiming for a bigger property and you’re still quite young, it may be a worthwhile strategy to forgo living in your own home for a while, continue living with mum and dad, and purchase an investment property instead. You can move into it a few years down the track when you have a few pay rises up your sleeve and do not need to rely on rental income anymore. You may forgo the first home buyer benefits, but you may still come out ahead if the property value grows quickly. Discuss this with your parents if you like.
Know Your Costs
Now you have your home loan pre-approved for a particular amount. Great!
Remember to also look at your savings, not only the pre-approved loan amount. There are banks who can work with 5% deposit. But there are additional costs which can be loosely broken down into 3 groups:
- Stamp duty: You can get a reasonably accurate estimate of stamp duty through a third party website such as www.stampdutycalculators.com.au, but in NSW for most properties it is around 4% of the property purchase price. In NSW, you can currently get stamp duty waived completely if it is your first property, you will live in it and the purchase price is not more than $650,000 (a reduction in stamp duty is available for homes up to $800,000). Vacant land has lower thresholds in NSW. In addition to stamp duty waiver or reduction, first home buyers buying or building a brand new home in NSW will also receive a $10,000 grant, subject to certain conditions.
- Lender’s mortgage insurance (LMI): If you are borrowing more than 80% of the property value, i.e. 80% Loan to Value Ratio (LVR), in most cases you will need to pay lender’s mortgage insurance (LMI). The cost of LMI depends on a range of factors, but for a first home buyer purchasing a $650,000 property to live in and borrowing at 95% LVR, the LMI is typically around 4% of the property purchase price.
- Incidental costs: There are other costs such as solicitor cost (typically around $1,500), removalist cost (perhaps budget for $500), pest and building inspection report (if buying a house; typically around $500), strata report (if buying a unit; typically around $250), lender fees (let’s say $500), fees to the land title office (around $500), and “adjustments” for items such as council rates, water rates and strata levies already paid by the vendor ($1,000 – $2,000). These incidental costs add up to $3,500 – $5,500 in most cases.
It is important to clarify your home loan pre-approval conditions with your mortgage broker or lender. Some lenders can pre-approve you for 95% of the property value + generous or unlimited allowance for LMI. More often than not though, you can only borrow 95% of the property value, including LMI. This means instead of contributing 5% deposit, you need to effectively contribute around 9% deposit (5% towards the property and around 4% towards the LMI in the above example for a first home buyer in NSW purchasing a $650,000 property). You also need to set aside $3,500 – $5,500 to cover the incidental costs mentioned above. Remember that LMI depends on a range of factors and a good mortgage broker or lender will be able to give you a more specific figure for your particular scenario. You may also need to pay for stamp duty if you do not fit the criteria to get it waived, for example if you are buying the property for investment (even though it is your first property).
Therefore, as a first time property purchaser, buying a property for investment does not necessarily mean you can buy a bigger property. Your pre-approved loan amount may be bigger, but you need to pay stamp duty and you may not have enough savings to pay for this extra cost item. Worse still if you are buying a brand new property in NSW, you will not receive the $10,000 grant. Of course, your parents may be happy to pay for the stamp duty for you and give you extra $10,000 on top, if they are nice.
If you like everything to be on the safe side, ideally you also want to have further savings left over, in case the bank’s valuer deems the property value to be lower than your purchase price, and you need to cover the difference with cash. In the current market, this happens quite often and does not necessarily indicate that you are overpaying for the property.
If you are buying for investment, I would suggest not maxing out your pre-approved loan amount and go 5% lower, because the rental income may be valued at a lower figure by the bank’s valuer, and this will reduce your borrowing power. Check what rental income your broker or lender put down on the system to obtain the pre-approval.
Go Back to Your Shopping List
Now that you have your home loan pre-approval in place and know what additional constraints may be placed by your cash savings, it is time to go back to your shopping list, inspect the properties you saved earlier if they are within your budget, or find cheaper ones if they are not. If you saved those properties on www.realestate.com.au, you will get an email every Friday evening, with a suggested Saturday inspection plan.
Once you find a property you really like, go back to it 2-3 times. Perhaps bring your family and friends. They may notice something which you did not see before, such as a leaking tap or a half-broken bedroom window. Go back to it at different times of the day, perhaps it is noisy at night due to a nearby train line.
Make an Offer to Purchase
At this point, you have found a property you like and within your budget. There are two ways forward: you can do all of your checks and then make an essentially unconditional offer to purchase; or you can make a verbal offer, do some checks if the verbal response is favourable, then make a conditional written offer, and then do more checks.
What checks do you need to do, you may ask? You need to ask for the draft contract of sale and get it reviewed by your solicitor. You should also order a pest and building report for a house (a “must”, typically around $500), or a strata report for a unit (“highly recommended”). Often the selling agent already has a strata report, or has organised a “bulk buy” for a cheap price (e.g. around $50 instead of $250). For a relatively new building, the subsidised strata report should be good enough. You or your mortgage broker also need to order a valuation report from the bank (usually the first valuation is free, but if you back out and buy a different property, you may need to pay for the second one).
You see, there are essentially 3 sets of documents to be ordered or reviewed, and this costs money. Therefore you want to make a verbal offer first and make sure the vendor plays along. If the vendor is receptive to your verbal offer, let your mortgage broker know that you are about to make a written offer. A good mortgage broker can provide an educated opinion about whether the property is likely to be satisfactory to the lender or not, and they will also work out whether to order the valuation now or later. If your broker says the property should be okay, order the pest/building/strata report and then make a written offer subject to 3 things + 1 disclaimer: satisfactory contract review by your solicitor, satisfactory pest/building/strata report (also mention to them that you have already ordered the report and are waiting for it), satisfactory finance approval (which takes into account the property valuation and rental income valuation), and lastly a disclaimer at the bottom of your email that no contractual obligation is created until after formal contract exchange.
By submitting a written offer, you are showing the vendor that you are serious and you will be kept in the loop with any offers from other prospective purchasers. If there is a lot of demand for the property, you can also subject your offer to the property being taken off the market. However the vendor may not entertain this if your offer has a number of other conditions. It is also good practice to include an expiry date with your offer, both to protect yourself and also to give a sense of urgency to the vendor.
Auction or Private Treaty
There are two main ways a property is sold on the market: through an auction (public offer) or private treaty (private offer). For a first time property buyer, I suggest going the private treaty route. Auction comes with greater risks, because your winning bid is binding with no cooling off period, so this means you either have to get all of the above 3 sets of documents reviewed first (contract, pest/building/strata report, and valuation report), or take a bit of a gamble and hope that everything works out. Some solicitors offer to do contract review at no charge, but they may start asking for money after you go to 5 different auctions and give them 5 contracts to review. Pest/building report usually costs around $500, so this can be $2,500 if you have had a go at 5 auctions unsuccessfully. Valuation report is typically around $200, but some banks will subsidise it.
If you fall in love with a property which is up for auction, you can make an offer to purchase prior to the auction date. In the current market, most vendors will entertain pre-auction offers. One risk with this strategy is it may start a pre-auction bidding war because the vendor’s agent will start contacting everyone who visited the open homes. If you are buying for investment and are indifferent about this particular property, it may pay to wait until after auction and make your offer after it gets passed in (fails to have a winning bid). Please be aware however that in NSW, if the contract is exchanged on the same day as the auction, there is no cooling off period even though you did not bid during the auction. Other states/territories may have their own rules.
Exchange Contract
You have made your written offer and it has been accepted. You are now ready to sign and exchange the contract (by the way, written offer is optional, you can skip straight to contract signing). A property contract of sale is typically signed separately and then the copies are swapped (exchanged). You sign one copy and give it to the vendor (through your solicitor or the vendor’s real estate agent); the vendor signs another copy and gives it to you (through their solicitor or real estate agent).
A standard contract of sale in NSW offers 5 business days cooling off period. You can back out of the contract at any time before 5pm on the fifth business day after the day on which the contract was exchanged, except in limited circumstances. You can always negotiate a longer cooling off period prior to signing.
The cooling off period is usually the time for your solicitor to iron out the contract (if it hasn’t already been done at the offer stage), and for you to wait for the bank’s valuer to value the property and for the bank to assess the valuation report and formally approve the loan. You may also still be waiting for the pest/building/strata report, depending on the turn of events.
If you choose to exercise your cooling off rights, in NSW you will lose 0.25% of the property purchase price (this works out to be $250 for every $100,000). Hence a strategy is to make a written offer and requesting valuation and formal loan approval as soon as the offer is accepted. You then organise a meeting a few days later to sign the contract of sale in front of your solicitor or the vendor’s real estate agent, and pay the deposit. If you are lucky, the valuation may have come back, you can cancel the meeting if the valuation is too low and you may not have to pay anything if your offer to purchase was worded appropriately. If you are unlucky however, the vendor may sell the property to somebody else, because an offer may not be binding even though it has been accepted.
How much deposit do you need to pay, when and how? Usually you are expected to pay 10% deposit when you sign the contract, with a bank cheque, personal cheque or internet banking transfer. However you can negotiate this figure down to 5%, and you can also negotiate to pay it when the cooling off period expires. You almost always have to pay at least 0.25% upon signing the contract. If you do pay only 0.25% upon signing the contract and the balance when the cooling off period expires, you may want to consult with your solicitor to confirm that the contract does not need to be amended to specifically allow for this. In some cases the vendor may be able to use your incomplete deposit as an excuse to back out of the sale, if they find another buyer offering a higher price.
Sit Back and Relax for a few Weeks
You have signed the contract of sale. After a few days your solicitor should have finalised any modifications to the contract. If you’re lucky you also have received formal approval from the bank. If not, you can request an extension of the cooling off period, which is usually given. You wait a few more days anxiously, it’s all part of the experience, and you finally get your formal unconditional approval from the bank.
Congratulations! Now it’s time to sit back and relax for a bit. In NSW a standard contract of sale has 42 calendar days settlement period, which means you will officially own the property 6 weeks after you exchange the contract. You still need to go over the loan documents and sign them in the correct spots with the correct signatures, but for the most part, the property is yours!
Get Ready for Settlement
Your solicitor will provide you with detailed instructions regarding the settlement procedures, and there are a few different ways to do this. The below outline is the method which the majority of my clients choose in consultation with their solicitors. Essentially, you need to make sure you have your funds ready to pay for the remaining deposit, stamp duty, and any fees and adjustments. Those funds must be in the correct account(s) on the day of settlement and your solicitor must knows where those funds are.
When do you need to pay the remaining deposit and how? You pay the remaining deposit on the day of settlement. The most common way of paying for the remaining deposit is to transfer the money 3 business days in advance into your solicitor’s trust account, to ensure it is ready and cleared on the day of settlement. It is also possible to provide a bank cheque made to the correct party, but not a personal cheque. If your money is currently with a bank which does not have a full-service retail branch, you need to plan 1-2 weeks ahead. Check your online banking transfer limit, ask if they can transfer a bigger amount over the phone or at the branch, and potentially break up the amount over several days if necessary.
On top of the remaining deposit, you also want to include typically another $2,000 – $3,000 to cover the lender fees, fees to the land title office, and “adjustments” for items such as council rates, water rates and strata levies. Your solicitor will give you a precise figure usually the day before settlement, you may need to top up the funds you previously provided to your solicitor’s trust account. Alternatively, if you have nominated a shortfall account when you completed the loan contract, you can also transfer this shortfall amount into that account (this is usually only applicable with major banks).
When do you pay the stamp duty and how? In NSW, stamp duty for most transactions is payable on the day of settlement, or 3 months after contract exchange, whichever is earlier. This is usually paid to your solicitor’s trust account or directly to the government via BPay. Best practice is to pay it 3 business days before settlement. If you are buying an off-the-plan property in NSW as your main residence, you have 15 months to pay the stamp duty, but you need to pay it on the day of settlement if it is earlier. If you are buying an off-the-plan property in NSW for investment, you still need to pay the stamp duty within 3 months.
If you are moving in, you can start booking a removalist and shopping for furniture now, to be delivered in the afternoon of the settlement day.
You will also be invited to do a pre-settlement inspection, usually around 5 days before settlement. Check that the property is still in the same condition as it was last time, there are no unexpected damages and no missing appliances if they are meant to be included.
Settlement Day
This is the big day.
You will be notified by your solicitor that settlement has taken place. Sometimes it takes a few more hours for the vendor’s solicitor to notify the real estate agent. After this happens, they will contact you and you can collect the keys to your new home!
There will be a little bit of housekeeping which we will touch on in another article.
Congratulations!