Step 1: Finance – How to Afford Property

The first and most important step in the Off the Plan Process is finance. What is finance? It is working out how much you can afford at different stages of the buying process. In this step you will learn how much deposit you need to buy Off the Plan property, how much borrowing you can achieve, what sort of repayments you can afford and what sort of costs are involved.

Step 1.1: Deposit
Step 1.2: Borrowing
Step 1.3: Repayments
Step 1.4: Costs

Step 1.1: Deposit

Off the Plan deposits are usually 10% of the purchase price. In some instances they are 5% of the purchase price.

Correctly understanding how to fund your Off the Plan property deposit is crucial as some methods may actually enable you to exchange on a property you otherwise thought wasn’t possible.

Before we outline the differing deposit methods it is important to understand how to actually save for your deposit. This simple step can help speed up your deposit savings, which in turn can enable you to buy a property sooner.

Saving

If you can learn the 10 rules for saving then you will place yourself in the best possible position to maximise your savings towards your deposit goals. Usually you are told to create a budget and stick to it! These rules aren’t set in stone, but they give you a guide on simple measures that can be undertaken for a year or two to increase savings towards your deposit goals and will enable your budget to be easier to follow.

Rule 1 – Save 10%-20% of wages your receive from each pay check and put that money into an online savings account to accrue interest
Rule 2 – Sell unused items on online websites like ebay or gumtree
Rule 3 – Work overtime at work or take on a second job after hours such as a bartender
Rule 4 – Plan your shopping, utilise discount stores where practical, maximise your spending on nutrient rich food and only buy takeaway food when you can’t make it yourself
Rule 5 – Start a small side business or rent a spare room in your residence
Rule 6 – If you have a partner encourage them to increase their savings and potentially pool your funds together
Rule 7 – Up-skill so you can take on more responsibility at work
Rule 8 – Re-train if you are considering a move into a different industry
Rule 9 – Downsize your car, use public transport and walk more where practical
Rule 10 – Start off with a lower price point property and gradually work your way up over time

The most important part of saving more for you Off the Plan deposit is being disciplined. Create a budget and stick to it, is easier said than done. If you have clear rules to follow then a budget is much easier achieved.

There are five methods used when paying for an Off the Plan deposit:

Step 1.11: Cash
Step 1.12: Deposit bond
Step 1.13: Bank guarantee
Step 1.14: Equity
Step 1.15: Borrowing from family or friends

Step 1.11: Cash

The most preferred method to a developer for an Off the Plan deposit would be cash. It is easily transferred and is the fastest type of deposit. If a new development site experiences incredible demand cash would be the method of choice for the 10% deposit. Below is an outline of a cash deposit versus a non-cash deposit.

Cash Deposit Non-cash Deposit
Fast and efficient to transfer Can be slow and have time delays
You know you have the 10% deposit when settlement happens When using another method like a deposit bond you need to make sure you have the 10% deposit when settlement occurs

Step 1.12: Deposit Bond

A deposit bond is used as a guarantee instead of a cash deposit to cover the period between contract exchange and contract settlement.

How does a Deposit Bond work with Off the Plan property?

Deposit Bond Process

A deposit bond is not a physical cash substitute when used.

It’s effectively a guarantee or insurance provided by an insurance company to ensure funds are paid at settlement period to the developer.

It still means purchases will need to pay the deposit at a future date.

The deposit bond delays payment of the 10% deposit from exchange to settlement.

What happens if you default under the terms of the contract of sale?

In a normal series of events, settlement will take place and the deposit bond will lapse.

When settlement doesn’t occur the developer has the right to go to the insurer and claim the guaranteed deposit.

After which the insurer will look to the purchaser for recovery of the money.

The purchasers remain responsible for completion of the contract including any costs and fees associated with the default.

What is the maximum amount for a Deposit Bond?

Traditionally a maximum deposit bond up to 10% can be used.

Benefits of Deposit Bonds:

  1. Savings remain intact.
  2. Convenient and quick alternative when your deposit money isn’t immediately available i.e. tied up in your current home, term deposit or other investment.
  3. Can enable a purchaser to buy at a VIP launch.
  4. Expensive bridging finance can be avoided.
  5. Deposit bonds can be used for property purchased in SMSF, trusts or company names.
  6. They are usually an inexpensive method which can usually be arranged in your local bank.
  7. They can have a long-term timeframe up to 4 years.
  8. Can enable a purchaser to buy Off the Plan property.

Must developers accept Deposit Bonds?

Developers do not have to accept a deposit bond on Off the Plan property purchases. Therefore you need to make sure the vendor accepts the deposit bond before committing to using it as your deposit option.

What types of Deposit Bonds are there?

There are two types of deposit bonds:

  1. Finance backed – are deposit bonds with less than a 6 month settlement period.
  2. Equity backed – are deposit bonds with more than a 6 month settlement period.
  • Deposit bond on loan approval – this follows the lenders approval process and will be issued in-line with the unconditional loan approval. It is usually the quickest method and generally has a 12 month expiry date.
  • Deposit bond not requiring approval from the lender – this is a more involved process and has more paperwork, similar to applying for a loan. A deposit bond of this type can be valid for up to 48 months. However you usually are required to hold an existing property with equity equal to at least four times the value of the bond.
  • Low-doc deposit bond – this deposit bond is secured against existing equity in your current property. Usually you just need to add the loan amount on your existing property and the deposit bond amount and if the total is less than 80 per cent of your current property’s value then you will meet the requirements.

Timeframes for Deposit Bonds

  • Short-term – 3-6 month periods are ideal for Off the Plan purchasers with properties nearing completion.
  • Long-term – 12-48 months are ideal for Off the Plan purchasers with a longer term settlement period.

Who can use a Deposit Bond?

  1. An off the plan property purchaser can use deposit bonds to purchase property they otherwise wouldn’t have been able, due to limited deposit funds.
  2. Existing property owners use deposit bonds to expand their property portfolios.
  3. Property investors can use deposit bonds to purchase more investments.
  4. Downsizers can use deposit bonds, particularly when they haven’t sold their principal place of residence.
  5. First home buyers can use deposit bonds to top up to the full 10% if they have a shortfall of available funds.
  6. Purchasers with funds tied up in non-liquid assets can use deposit bonds.

Are Deposit Bonds a cheaper alternative to Bridging Finance?

A $50,000 deposit bond to cover a 10% off the plan deposit over 18 months, will cost you around $2,250. Alternatively bridging finance would cost approximately $4,000 based on 5.34% interest p.a.. This is a saving of $1,750.

Are Deposit Bonds legal in Australia?

Yes, they are legal and available in all states.

When do Deposit Bonds terminate?

  1. Contract of sale being completed.
  2. Expiry date.
  3. Contract of sale terminated or rescinded.

What do you usually need to apply for a Deposit Bond?

You will need to provide enough evidence showing how you will be able to pay the full purchase price at settlement.

    Documents usually required:

  1. Off the Plan property contract of sale.
  2. A copy of your loan approval.
  3. Evidence of other money you will be using i.e. An Australian bank savings account statement.
  4. If you are a first home buyer, a copy of your completed First Home Owner Grant Application or approval letter.

Step 1.13: Bank guarantee

A Bank Guarantee is another alternative to the cash deposit when buying Off the Plan property. The Bank Guarantee is an unconditional undertaking given by the bank, on behalf of their customer, to pay the vendor of the guarantee the amount of the guarantee on written demand. Bank guarantees require security in the form of cash or real estate.

Benefits of the Bank Guarantee

  • Useful for cashflow when no cash is available as it may be tied up in other investments
  • It is secured against cash or assets and enables you to meet your contractual obligations whilst having the deposit secured in your bank account
  • Cash held in the bank can earn interest during the settlement period
  • Bank Guarantees can be flexible being open-ended or have expiry dates
  • A Bank Guarantee provides assurance to the developer of payment if they make a written demand to the bank on the Bank Guarantee

Example of Bank Guarantee Fees and Charges on $600,000 Off the Plan property

Establishment Fee Ongoing Service Fee
0.5% of service amount 1.5% payable per half year in advance
$300 $900

Step 1.14: Equity

Equity is the difference between your property’s market value and the balance of your mortgage.

Example of using equity to fund Off the Plan property

Assuming you already own a property with a current market value of $700,000 and you owe $400,000, you have $300,000 worth of equity. If you are looking to buy an Off the Plan property valued at $600,000 which would usually require a 10% deposit you will need $60,000. Assuming you meet the requirements of the lender, they will lend you up to 80% of the value of the property minus the outstanding mortgage.

Current market value ($700,000) x 80% = $560,000

Amount owed on the property = $400,000

Total usable equity = $160,000

How much of this usable equity can be used towards an Off the Plan property

In our example, the $600,000 will have a $60,000 deposit. This usable equity can be used towards this. In addition, assuming the full $160,000 is usable, the extra $100,000 can be used when the property comes to settlement. *Usually lenders will let you borrow around 4 times the usable equity in your property. In this example this would equate to $160,000 x 4 = $640,000.

Benefits of using equity to fund your deposit

  • If it’s available it makes sense to use it wisely
  • This is one of the main ways successful investors expand their portfolio
  • You will be implementing the theory of compounding

What sort of costs are involved in funding an Off the Plan deposit through equity

The main cost associated with the deposit is the repayments on the deposit.

*Assuming the Off the Plan property settles in 12 months time. For a $60,000 deposit at a 5% interest rate, you will have spent $3,000 over that period of time.

Step 1.16: Borrowing from family or friends

Borrowing from family or friends is a common way first home buyers or buyers short on cash raise money to cover the 10% deposit. Usually there is some formal agreement between lender and borrower to cover all scenarios.

Benefits for borrowing from family or friends

  • A great way for a first home buyer to get help in entering the property market
  • Forces the borrower to become prudent and responsible with spending habits to ensure repayment
  • If you find the perfect Off the Plan property then you won’t miss out
  • Is generally on better terms than borrowing from a lending institution

Step 1.2: Borrowing

If you can understand your borrowing capacity then you are in a position to work out which areas you can afford to buy in, the types of property you can afford such as apartments, houses or townhouses. The key factors affecting your borrowing capacity are 1) Income, 2) Expenses and 3) Interest Rates. Below is a borrowing calculator to help you understand differing borrowing scenarios.

Important note: Our calculators are only estimates and do not take the range of factors when assessing applications and providing home loans. Please consult your mortgage broker before applying for a loan.

Step 1.3: Repayments

Once you have an understanding of how much your repayments will be, you can plan a budget accordingly. Australian’s are on average spending 27% of pre-tax income on housing costs. Below is a repayment calculator that will help you understand how much it will cost to repay your home loan.

Step 1.4: Costs

It is important to understand the costs associated with property ownership.

Off the Plan property has the distinctive advantage in having a period between exchange and settlement whereby you can often save and prepare the finance well in advance.

There are four stages when owning property and within each stage they have associated costs.

    Step 1.41: Upfront costs
    Step 1.42: Settlement costs
    Step 1.43: Holding costs
    Step 1.44: Sales costs

Step 1.41: Upfront costs

  • 10% deposit
  • Not so much a fee as a necessary requirement for purchase of Off the Plan property. Nonetheless it is an amount required upfront to exchange on the property.

  • Conveyancing fees
  • The conveyancer will analyse your contract and undertake any searches needed for the successful exchange of the property. Usually they charge a percentage of the total fee in this upfront stage.
    Finding a conveyancer at the start of your search will make it a smooth process.

  • Stamp duty
  • Stamp duty rates vary around the country. Below are examples for NSW, VIC and QLD stamp duty rates based on $600,000 purchase price. The table also shows how the first home owners / investors grant effects each state.

    State Normal rate Est. off the plan rate with grants
    New South Wales $22,819 $17,819
    Victoria $32,553 $5,510
    Queensland $20,000 $20,000

Step 1.42: Settlement costs

  • Balance of deposit
  • At settlement you will pay the balance of the deposit, which is usually another 10%. Making 20% in total to settle on the property. If this is not done, then you may require Lenders Mortgage Insurance (LMI).

  • Lenders Mortgage Insurance
  • LMI is an insurance which credit providers take out to protect themselves from borrowers not being able to repay the loan.

    Example:
    If you purchased a $500,000 property and only had a 10% deposit i.e. $50,000 then you would need to borrow $450,000 or 90%. In this case the LMI would equal about $8,820 which is usually paid in the form of cash or collateral or in some cases can be capitalised into the loan. *This is instead of coming up with another 10% deposit i.e. $50,000. An effective saving of $41,180.

  • Mortgage Fees
  • Usually when you start a new mortgage you are charged an ‘establishment fee’ which is basically a once off fee to set-up your loan.

    If you don’t pay this upfront, some mortgages may charge you higher ongoing fees.

  • Conveyancing fees
  • The conveyancer will charge you an upfront amount during the exchange stage and the balance on settlement.

Step 1.43: Holding costs

  • Body corporate fees
  • The body corporate keeps the development maintained and up to a high standard taking care of garden maintenance, common area and lifts. Depending on the development, these can range from $2,000-$4,000 per annum.

  • Council rates
  • Payable to the local council who look after bin collection and roads. These rates depend on the property within the development. A rule of thumb would be around $1,200 per annum.

  • Water rates
  • Payable to the water company who monitor water usage. Generally around $1,000 per annum.

  • Insurance
  • Insurances cover the property for a variety of events such as theft, damage and some natural disasters.

  • Land tax
  • Every state in Australia has differing land tax rules and rates. Below is an example for NSW, VIC and QLD.

    State Land tax threshold
    New South Wales $482,000
    Victoria $250,000
    Queensland $350,000
  • Repayments
  • In 2016 we are in a low interest rate environment with many providers offering competitive rates below 4%.

  • Property management
  • If you are investing in property then a property manager is absolutely necessary and will manage the property’s rental payments, expenses and advertising to find and select new tenants.

Case Study: Comparing holding costs when buying to invest or live

Description Buying to live Buying to invest
Salary $100,000 $100,000
Plus rental income $0 $32,000
Less interest $32,400 $32,400
Less property expenses $2,400 $5,000
Taxable income $100,000 $94,600
Tax + Medicare levy $26,347 $26,347
Net income $73,653 $68,253
  • Depreciation schedules
  • If you purchased the Off the Plan property for the purposes of investment, then you will need to organise a depreciation schedule to maximise your tax deductions. Charges typically range around $500 for a comprehensive schedule. Off the Plan EXPRESS clients will receive a depreciation schedule for their first years depreciation.

  • Accountant fees
  • In order to maximise your depreciation and associated holding costs with an investment property it would be smart to use a qualified accountant to help you maximise your tax deductions.

    Step 1.44: Sales Costs

    • Legal fees
    • Your conveyancer will create a contract of sale enabling the real estate agent to list the property.

    • Agent’s fees
    • Real estate agents will charge a fee to sell the property which can range from 1.5%-2.5% plus a variety of advertising costs.

    • Advertising costs
    • The agent will also charge an advertising fee covering online and offline advertising.

    • Capital Gains Tax
    • Capital gains tax (CGT) is payable on a property when capital gains are made. It forms part of your income tax and is not a separate tax, however it is referred to as capital gains tax. If your capital losses exceed your capital gains in an income year, you can generally carry the loss forward and deduct it against capital gains in future years. Most personal assets are exempt from CGT such as your own home.

    As we have a thorough understanding of finance, we will now move to your buying plan.