Settling a loan is very important to owning your property someday

The settlement of a loan is the act of paying back the amount of money owed to the lender. If you've ever been out on the town and had to settle your tab before leaving an establishment, you're familiar with the notion. This makes sense, because a loan settlement statement details how you are expected to pay back your debt to the lender.

In terms of purchasing property, the details of a loan will usually be delivered to the borrower by the bank (or other lending institution) in a loan settlement statement.

What is a loan settlement statement?

A loan settlement statement is the document that describes the amount of a loan, typically for a mortgage, given to the borrower once the loan has been settled. In addition to the amount, the settlement statement will also contain the frequency of installments expected from the lender in regards to repayment.

It will be written up by the lender, usually a bank but possibly another lending party, at the close of settlement.

Is a loan settlement statement different from a normal settlement statement?

Quick answer: yes. It's not uncommon to mix the two up, though, because a "settlement statement" is another document that's involved in buying a home. So how do you keep track of which one is which?

A settlement statement explains and accounts for all fees and rate adjustments like stamp duty, government levies, or water and council rates. In other words, it's an itemized list of every financial transaction involved in closing on a house from both the buyer and the seller.

A loan settlement statement, meanwhile, is a document detailing how much money you owe and how the bank (or another lending organization) expects you to pay the money back.

That's the difference between the two. The first is a list of expenses from buyers and sellers in the closing process, while the other details the specifics of your loan/mortgage.

What does a loan settlement statement look like?

As an example, let's say you were approved for a mortgage valued at $200,000 to be paid back over 10 years with a 4% interest rate for the purchase of a property worth $235,000. Now let's say that you and your lender agreed that you would make monthly payments on your loan.

All of this information will be detailed in the final loan settlement statement, as well as the repayment details.

It will detail the loan in a way that might look something like this: "Jane, the buyer, has entered into a contract with John, the seller, for the purchase of John's property on this date. The purchase price was $235,000, and Jane will be receiving a loan for $200,000, or 85% of the purchase price, to be repaid in monthly installments of 2,024.90 over the ten-year duration of the loan at 4% interest, for a total of $242,988.00. The rest of the purchase price was paid for in a deposit by Jane to the amount of $35,000, and will not be included in the loan."

How did the lender get to $242,988? Well, a 4% interest rate on this loan broken into monthly repayments would result in a monthly bill of $2,024.90 – evenly dividing the $200,000 principal as well as the interest percentage over the span of the loan, according to our home loan calculator.

It's also worth noting that, if Jane paid her mortgage back in weekly installments, rather than monthly, she could be saving just over $250 off of the total interest. Not a huge amount of money compared to the total value of the loan (or the property, for that matter), but certainly a nice amount to not have to pay back.

When will I receive my loan settlement statement?

You will receive your loan settlement statement at closing, when all parties involved in the sale are signing forms and making sure everything is in order. It is in the lender's best interest to give you the settlement statement as soon as possible, because that way they will know you are officially aware of the terms and conditions of your loan repayment.

Is there any downside to settling a loan early?

On the surface, paying off your loan before the terms agreed to seems like an obvious decision. If you're looking at a mortgage, it's likely that this is going to be the largest debt that you encounter in your lifetime, and the faster you settle your debt, the less interest you'll pay. Seems like a clear-cut decision, right?

Not necessarily. In this case, it's very important to read the contract: Your lender may not have allowed you the option of early repayment in the contract, so even if you have the ways or means of settling early, you may not be able to.

Alternatively, you may find that a lender will allow you to settle your loan early but they will charge you a fee, sometimes a significant one.

Why would lenders do this? Well, whenever you enter into a loan, you are almost always going to pay interest on the amount you've borrowed – otherwise the lender wouldn't make any money from the loan, which, unless you're borrowing from "the bank of Mum and Dad", is not why they loaned you the money in the first place.

If you've signed a ten year loan with a bank, they were banking (pardon the pun) on having ten years of monthly payments and the interest that went with them. If you pay it off all at once, their revenue source – your interest payments – dries up.

All of this information will be detailed in the terms and conditions of your mortgage, but because many of these documents are written in very specific language that can be difficult to decipher, you can call your lender directly if you are unable to find it in the contract.

What about a property settlement statement?

A property settlement statement is a third thing entirely: an agreement between divorcing spouses that divides their assets between both parties.

While it sounds similar to the other settlement-related terms, it does not have to do with purchasing property.

Are there any risks involved in settlement?

There is always a risk that one party (such as the buyer) may fail to deliver the terms of a contract with another party (such as the lender) at the time of settlement. This is called settlement risk. In this case, for instance, the buyer might not be able to meet the legal obligations of a loan and end up defaulting on it. Common causes of settlement risk include not getting pre-approval on a loan, not putting a “subject to finance” clause in a private sales contract when putting down a deposit, and buying off-the-plan (buying a property that has not yet been built on the basis of the planned construction).

How do you end up with settlement default?

If you encounter one of the following situations, you may have to default on settlement:

  • The size of your existing debts, including mortgages, has become greater than your income (It is important that you consolidate any debt before applying for a mortgage)
  • Sudden events like job loss or business failure
  • Major changes in currency exchange rates (if you are an overseas buyer)
  • Change in government legislation, including changes to borrowing limits, tax policies, lending policies, tax benefits, or Foreign Investment Review Board laws

How do regulatory changes affect your settlement risk?

The regulatory changes government authorities make can increase your settlement risk. For instance, when the Australian Taxation Office launched a new program around the end of 2015 to ensure that property owners were meeting their tax obligations, the investment-property borrowing power of property investors significantly dropped. This, in turn, increased settlement risk as a result of the more restricted lending criteria set by banks.

How can settlement risk affect your finances?

Settlement risk is great for off-the-plan purchases because of the time between the signing of the contract and the completion of the project. Although the settlement risk is minimal when property prices are increasing, it rises significantly when property prices are falling or becoming stagnant.

As a result, you might be required to top up your deposit to make the LVR stack up to what was agreed on or pay for lender’s mortgage insurance (which can be expensive). Another possibility is that the lender might be unwilling to lend the amount they have agreed to pay for the property if it is significantly greater than the market value. And if you cannot top up your deposit, you might find it more difficult to get the home loan you need.

Failure to settle on an off-the-plan purchase might result in consequences such as losing the initial deposit. Depending on the terms of the contract, the worst-case scenario is that the property developer will sue you to recover costs as well as the difference between the contract price and selling price.

How can you avoid settlement risk?

Here are some of the things that you must keep in mind as a property buyer:

Buy comfortably within your budget

Avoid overstretching your finances. It is essential to give yourself some breathing space in case you need to tap into additional funds, such as at the time of settlement. It is, therefore, best to consult a reputable mortgage broker to help you determine how much you can borrow. If your mortgage broker tells you that you can borrow a maximum of $1 million, do not purchase a property that costs $1 million, as you will also need to consider other costs such as legal fees, land tax and stamp duty.

Prepare for the worst-case scenario

Off-the-plan buyers often commit the mistake of counting on the end value of the property rising higher than the contract price when they purchase it. To avoid settlement risk, you must arrange your finances to cater for the worst-case scenario – the property’s market value falling below the contract price. When the settlement day comes, you might need a larger deposit than the one you budgeted for. Thus, it is best that you use the time you have until the settlement day to continue saving in case you do need more funds.

Consider the changes in lender policies

The major banks and lenders have been changing their lending policies, making it harder for buyers to get finance. Lending restrictions have been imposed on investors and foreign buyers, and some banks are now refusing to lend in certain areas which they see as risky. For instance, property investors who could once borrow up to 95% of the property value may only be able to borrow up to 80% LVR now.

Buy for the long haul

If you are buying an investment property, you should buy as a long-term investment of at least 10 years. During this period, you will experience different phases of the property cycle and may see lower capital growth at times. However, if you are able to buy a property in a good location, you will likely see good and stable capital gains.

Enlist the help of a professional

If you are planning to buy an off-the-plan property, it is advisable that you work with an experienced legal professional in adding a protective clause to the sales contract. The clause should state that you are buying on the basis that the property is worth the price you will pay on completion and if it is not, you will not be obliged to settle and your deposit will be refunded. But even if you are not buying off-the-plan, it is still a good idea to seek the help of a mortgage professional to arrange pre-approval on your loan to avoid settlement risk.

You need to be aware of settlement risk and its impact on your property purchase journey, but it should not prevent you from buying a property. While it is difficult to predict when a settlement risk may occur, the important thing here is that you have a plan in place and know how you will handle the situation if this risk arises. By following the guidelines discussed above, you will be able to avoid (or at least reduce) this risk.

Also read:

What happens if the buyer delays the settlement?

What are your rights when settlement is delayed?

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