Finance clause - What does it mean

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Sam and Rhys recently had a chat about finance clauses over a beer on Friday afternoon. Below we go into detail about what finance clause means, when a finance clause may be useful and some tips and traps for purchasers and vendors.

WHAT IS A FINANCE CLAUSE

Most buyers of residential property need to obtain a loan from a bank or other lender to pay for their property. Often buyers will get what’s called pre-approval from their lender, before finding a property and making an offer. Pre-approval is an in principle agreement to lend the money, but not a final commitment to the loan. Some buyers don’t have a pre-approval. In either case, it often means that when the buyer is exchanging the contract to buy the property, they don’t know yet whether their lender will actually lend the money to fund the purchase. This is a risky situation – if the buyer commits to buying the property and can’t pay for it, they will breach the contract. Unless there is some way to avoid the contract, the seller will be entitled to terminate the contract and the buyer will lose their deposit (and potentially be sued for damages). Given the deposit is usually 5-10% of the purchase price, it’s a tragic outcome for the buyer.

Enter the finance clause. A finance clause is a clause in the contract for sale and purchase of land that provides that the contract (or completion of the contract) is conditional on the buyer obtaining formal approval of a loan to fund the purchase of the property from their lender. Finance clauses generally fall into two categories: self executing and non-self executing. In either case, they give the buyer a means of escaping their obligations under the contract, if their lender does not come through with their loan.

NON-SELF EXECUTING FINANCE CLAUSE

This type of clause provides that the buyer has a certain period to obtain unconditional finance approval from a lender. The buyer can’t rest on their laurels, they are required to do everything reasonably necessary to get the loan. If they don’t get the loan during the specified period, then either they or the seller of the property can rescind the contract (essentially tear it up) and both parties can walk away. Sometimes, a buyer will need to pay the vendor an amount of money if they rescind the contract, effectively to reimburse the vendor for their legal costs and inconvenience, but not always. Sometimes, the clause provides a limited period for the contract to be rescinded; for example, if the buyer doesn’t obtain finance in the specified period, then either party can only rescind the contract during the next 7 days. If the contract is not rescinded during that time, the right to do so is lost. In other cases the right to rescind is open ended.

SELF-EXECUTING FINANCE CLAUSE

A self executing clause works a little bit differently. It provides that the buyer only has a certain period to rescind the contract if they don’t obtain finance, say 10 days. If the buyer does not rescind the contract during that time, then the right is lost.

BENEFITS FOR BUYERS

The key benefit for a buyer is that they can commit to buying the property before they have a commitment from their lender to fund the purchase. It means that they can proceed to exchange a contract without finance risk. Some banks won’t even consider a loan application until a contract is exchanged. In those cases, a finance clause is critical (unless the buyer is confident they can fund the purchase some other way). Even where lenders will provide approval before exchange, buyers are often keen to lock in the property so no one else can buy it. Waiting for a loan to be approved, particularly in a seller’s market, can be a stressful time.

If the buyer’s finance is approved, great, they proceed and complete the purchase. If not, they walk away without significant costs.

BENEFITS FOR SELLERS

The situation for a seller is double edged. On the one hand, a finance clause means that they can exchange the contract with a buyer who might otherwise not be comfortable committing to the purchase. It means that the settlement period starts and finalisation of the sale starts getting closer. But for the buyer’s finance falling through, the sale will complete as planned. On the other hand, it means that the property comes off the market and if the buyer’s finance doesn’t come through, the vendor has wasted precious marketing time. Depending whether the finance clause deals with legal costs, it may mean that the vendor is out of pocket too.

For a vendor, there is no right or wrong answer when a buyer proposes a finance clause. The particular circumstances need to be carefully considered.

TAKEAWAYS

Finance clauses are great for buyers, but might not always be so good for vendors. To learn more about this or any other aspect of conveyancing, buying or selling property, Get in touch with us.

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