'Subject to finance' clause: What is it and why is it important?

author-avatar By on August 03, 2021
'Subject to finance' clause: What is it and why is it important?

Property contracts are, more often than not, subject to finance. However, some experts suggest leaving out this safety net for a competitive edge.

There are many reasons to purchase a property right now. With record-low low interest rates and many government incentives currently available across Australia, it could be a great time to enter the property market as a first-time home buyer. However, it’s important to know the ins and outs of purchasing a property, so you don’t end up in a sticky situation.

For example, there could be nothing worse than saving up a hefty deposit and putting it down on your dream home, only to lose it and the house because you couldn’t obtain a loan. This is where a subject to finance clause can come in handy.

In this article, we’ll discuss:

What is a subject to finance clause?

A contract that’s subject to finance is pretty standard in the real estate business. All it means is that the buyer can back out of the contract if they’re unable to secure finance, and that they receive their full deposit back.

A subject to finance clause is different to a cooling off period, which is a short period that applies to most private sales in which you can still change your mind and call off the purchase. Cooling off periods don’t apply to houses sold at auction, and you will usually have to forfeit a small amount of your deposit (around 0.25%) to get out of the contract.

When a contract is subject to finance, it means that the sale is conditional upon the lender approving your home loan application that you need to fund your purchase. This doesn’t mean that the contract definitely ends without finance approval - just that you have the ability to get out of it if you need to.

Why using a subject to finance clause can be helpful

Using a subject to finance clause can be helpful in most property purchases, particularly if it’s not a cash contract. It serves as a layer of protection for you, the buyer, in case you’re unable to finance the purchase.

For some further insight, Simon Pressley, Managing Director of Propertyology, shared his knowledge about contracts that are subject to finance.

“Subject-to-finance clauses provide buyers with a form of ‘insurance’ in favour of their ability to raise the funds and be able to follow through with the settlement of a property,” Mr Pressley told Savings.com.au.

If your home loan application is rejected, without a subject to finance clause to save you, you could end up with no choice but to go ahead with the purchase anyway. With no means to actually purchase the property, you would likely lose your entire deposit, and potentially face legal action if the house sells for less than what you’d originally offered.

If you’re waiting for home loan approval after you put down an offer on a property, it might be worth asking for a subject to finance clause to be added to the contract. Even if you’re quite certain you’re going to be approved, it doesn’t hurt to list it anyway. That way, in the worst-case scenario wherein you don’t get home loan approval, you don’t end up stuck in a contract you can’t get out of.

There are, however, some situations in which a subject to finance clause will be purposely left out of a contract, particularly if there is competition for the property, or it’s a difficult market to crack into, according to experts.

“While it is best practice to include the clause, and a majority of property buyers definitely should, there are legitimate situations when certain buyers might elect to waive this clause for a strategic negotiation advantage,” Mr Pressley said.

“If a buyer can mitigate the risks of doing this, it could be the difference between getting into the market right now versus a few months’ time when the market may have moved up tens of thousands of dollars.”

Conditional vs unconditional: A contract speed session

A sale contract can either be conditional or unconditional, but what exactly does that mean?

A simple explanation is that a conditional contract has conditions that need to be met before the sale is completed, whereas an unconditional contract doesn’t.

To break it down a little further, a conditional contract means that the sale will only occur if all of the applicable conditions are met. These could be standard conditions, like a subject to finance or building and pest clause, or they could be customised to you personally. For example, do you want the property to be professionally cleaned? Do you want a specific tree cut down before you move into the property? You can ask your solicitor or buyer’s agent to write up a clause to be added to the special conditions of the contract. If you’re not happy with the outcomes of said conditions, you can either insist that they're met, proceed anyway, or back out of the contract. Once all of the conditions listed on the conditional contract are met, it becomes unconditional.

An unconditional contract, on the other hand, isn’t waiting for any special conditions to be met before becoming finalised. Meaning, the contract will go ahead with the terms and conditions stated, so it’s important to ensure you’re absolutely certain about your purchase. Unconditional contracts also waive the standard cooling off period, so as soon as it’s signed, the deal is sealed.

In a nutshell, conditional contracts are more favoured towards the buyer, as they have extra assurances and escape routes in place, in case something goes wrong. Unconditional contracts are more favoured towards the seller, as they have a level of assurance that as soon as the contract is signed, there’s no chance of it falling over (in most instances).

So, conditional contracts might be better if you have any uncertainties as a buyer, and an unconditional contract might be favoured if you’re trying to snag a hot property and you’re certain you’re happy with the initial contract.

“The key consideration is each individual buyer’s financial ability to fund the purchase. There’s a big difference between a buyer with a nominal deposit and a borderline debt servicing equation compared to a cashed up buyer with lots of equity and surplus disposable income,” Mr Pressley told Savings.com.au.

A quick guide to securing finance

All of this information might be well and good, but if you’re not even sure how to secure finance to begin with, it’s not particularly helpful. Here is a quick guide on securing finance to purchase a property, as a first-home buyer or otherwise.

1. Ensure you’re ready

First step, before submitting any home loan applications, is to make sure that you’re financially responsible and stable enough to take on a mortgage. For most people, buying a property is one of the biggest debts they will ever incur. Plus, it’s a pretty long-term commitment, with many mortgages extending for up to 30 years. If you’ve got any outstanding debts, make sure to try get them out of the way, so you can focus on repaying your new asset - your home.

2. Consider talking to an expert

If you’re not sure whether you’re ready, that’s totally okay. But at the same time, if you’re not sure, it might be worth talking to a professional about your situation before doing anything rash. Experts like financial advisers are a great resource at your disposal, as they will give you the best advice on how to maximise your investment. If they don’t think it’s the right time for you to purchase a property, they’ll let you know. Their job is to act in your best interest, and help you get the most out of your money. Otherwise, you could consider consulting a home loan adviser, or you could just walk into a bank and have a chat.

3. What’s your credit like?

In addition to the money side of things, having a good credit score is going to help you secure a mortgage. A credit score is kind of like a grade for your borrowing history, with your credit report being the report card. Your credit score is a number that’s calculated based on your borrowing history, so if you’ve been a responsible borrower in the past, chances are you have a good credit score. Typically, top-tier lenders only provide loans to people with top-tier credit. Making sure your credit is in check is going to make finding a suitable home loan much easier, it will give you better options to choose from, and it increases your chances of loan approval.

4. Do your research

There is no shortage of home loan products available. From banks to non-bank lenders to customer-owned banks, there are thousands of products on the market ready to be applied for. Home loan interest rates are currently at an all-time low, with many mortgage providers boasting their highly competitive offers. To make sure you’re getting the best fit for you, it might be worth doing your research. Find out what’s out there, what features you want in a home loan, how much certain lenders will let you borrow, etc.

5. Only apply for what you can afford

When mortgage providers assess your home loan application, one of the main things they will look at is your borrowing power. If you apply for a $1 million loan, but you’re only working one shift a week, odds are they’re going to reject your application. Know how much you can afford, and only apply for an amount within your budget.

6. Make sure you’re eligible

Lenders will look at more than whether you can afford the loan when processing your mortgage application. They also need to make sure that you meet their eligibility criteria. Otherwise, they can’t approve you for a loan. All lenders have their own eligibility criteria, but to give you an idea of what you might expect, these are some common factors mortgage providers will look at before reaching a decision:

  • Your age (typically, you’ll need to be over 18 years old)

  • Your legal ability to purchase a property, i.e. your citizenship status

  • Your present income

  • Your employment status

  • Your current assets and liabilities

  • Your credit score

  • Your deposit


Image by Tierra Mallorca on Unsplash

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Rachel is a Finance Journalist, and joined Savings in 2021. Coming from a background in the FinTech space, her interests include the innovation of lending technology, property, investing, and more. With a passion for educating and informing people about their finances, she hopes to increase the financial literacy of everyday Australians.

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