Despite the Australian Prudential Regulation Authority‘s (APRA) attempts to cool rising property prices in Australia, their decision to impose a number of brakes on investment lending has raised settlement risk.
So what does this mean for home buyers?
What is settlement risk?
At the time of settlement, there’s always a risk that one party may fail to deliver the terms of a contract with another party. This is called settlement risk.
A settlement risk can be associated with home loan default, where you’re unable to meet legal obligations of a loan, during settlement or any time difference in settlement between the two parties.
How do homebuyers end up with settlement default?
Capacity to settle
You may come across a situation where you have little option but to default on settlement. For example, if you have excess debt and can’t afford to make mortgage repayments.
Some factors that affect this include:
- Existing debt: If the size of your debts, including your current mortgages become greater than your income then you’ll end up with a default. It’s important that you consolidate any debt before applying for a mortgage.
- Personal circumstance: Sudden events like losing your job, loss of income or failed businesses can drive people to default.
- Change in government legislation: This includes changes to borrowing limits, tax policies, lending policies, tax benefits, or Foreign Investment Review Board (FIRB) laws.
If you’re an overseas buyer then you can be adversely affected by major changes in Australian foreign exchange rates.
Willingness to settle
Some property buyers are motivated by certain circumstances to default.
For example, between the period of sales and settlement, the price of the property may fall by more than what you may have deposited. In this situation, you can reduce your losses by defaulting.
Call us on 1300 889 743 or fill in our free online assessment form and speak with one of our expert brokers for more information.
How does it affect you?
Predicting defaults isn’t any easy process.
Typically, they can only be identified after you miss settlement.
It’s then followed by a lengthy process to nullify contracts and resell the asset.
Off the plan buyers
When the property market slows down with a lot of people buying off-the-plan, then during the time of settlement, there’s the risk that property values will drop compared to the contract price of the property.
This means that when you settle the property, it’s valued at a much lower price than what it was contracted for. You may then be required to top up your deposit to make their LVR (Loan to Value Ratio) stack up to what they agreed on.
They can also work out another arrangement with their lender but this can be a difficult if you consider the recent situation of the housing market.
How can regulatory changes increase my settlement risk?
Regulatory changes made by government authorities more or less add to your settlement risk.
For instance, around the end of 2015, the Australian Taxation Office (ATO) launched a new program to ensure that property owners were meeting their tax obligations. This program affected property investors, significantly lowering their investment property borrowing power.
As a result, the settlement risk also increased because of the more restricted lending criteria set by the banks.
If you would like to know more about how these changes can affect your settlement risk then call us on 1300 889 743 or fill in our free online assessment form today!
What risks can a default crisis incur?
According to CoreLogic RP Data head of research Tim Lawless, a rising number of new houses are being approved.
If the housing market were to soften at this point, many of these houses won’t reach the commencement and completion phases. This is due to the fact that some developers will pull out of the market or the rate of pre-sells won’t be met because of soaring buyer demands, he adds.
Can a possible default crisis be averted?
As mentioned earlier, it’s rather difficult to predict when a borrower might default or when a settlement risk can occur.
However, some measures that can be taken by the Australian government to avert the risks of a default crisis include:
- Creating a suitable market situation where the settlement value compared to the contract value is roughly the same, if not higher.
- Moderation of the growth rate, as well as declines in dwelling values. Sharper or more concentrated declines in areas of new supply, or new properties, mean the risk of defaults is substantially higher.
- Changes in lending policies to control the sharp rise in property prices. This can help maintain a more sustainable growth rate.
Disclaimer: The information mentioned above is general advice only. Please speak with your accountant or a professional finance advisor for legal advice.
What else does this affect?
- Cash flow: A default can result in delayed cash flow because of material delays in settling sales.
- Revenue: In a distressed market, it can be difficult to sell an asset or a property. The vendor may need to offer significant discounts to reduce overall exposure, which can result in loss of revenue.
- Extra expenses: This can include legal fees, interest and commissions from new sales for resells.
Settlement risk FAQs
What is a pre-settlement risk?
When one of the party of a contract fails to meet the terms of the contract and defaults before the settlement date is reached, it is known as pre-settlement risk. Basically, it’s the risk where one party prematurely ends the contract.
For example, you own a business and you’re using the income you earn from it to cover your mortgage repayments. If your business goes bankrupt then you’ll have no option but to default on the contract, provided that you don’t have any other source of income.
It’s important to consider all risks associated with mortgages before you decide to buy a property.
You can contact us on 1300 889 743 or fill in our free online assessment form to get more information on settlement.