The process of moving house and switching loans can be both a satisfying lifestyle choice and a smart financial move. However, it can also be risky and home owners should be aware of all their options and the potentially hefty costs of breaking a relationship with an existing lender.
It takes a strong man or woman to juggle houses. Many first-time borrowers enter the home-loan market without fully understanding the problems they may face if they decide to later switch loans or change homes. It is hard enough to manage a smooth move without losing your pets, your savings and your sanity. The problems multiply if you are also switching from one loan to another or trying to take a loan with you. Ending a loan contract with your finances and mind intact can be a major feat. You need to be familiar with concepts such as break costs, bridging finance and deposit bonds. A big question is whether to buy a new house then sell the old one or the other way around. There are pluses and minuses to either option.
Moving house should be a simple proposition. You find a new property that you like, sell your existing home at a nice profit, stroll out the front door of your old house and into the new one. Simple, right? Unfortunately the transition from one property to another is never that easy.
While a move from one home straight into another is the least stressful option for you and your family, it is not always compatible with the financial goal of selling your existing house at the best price and finding a new house that represents good value and is also appealing.
A matter of timing
This conflict usually boils down to a question of timing. The biggest decision for most home owners is whether to sell their old home before buying a new one or to buy first and sell later.
The first option, to sell then buy, is the most conservative. Having just sold your house you will know exactly how much you can afford to spend on a new home. This removes much of the stress from hunting for a new property and clarifies your options as far as obtaining finance.
Unfortunately this also usually means finding interim accommodation for the period between settlement on the sale of your old house and settlement on the new one. As well as being frustrating and stressful for the household, this can be an expensive option. While the cost of renting interim accommodation usually will not be much more than that of servicing a mortgage, there are several other costs to consider. The cost of storing your goods and chattels, two sets of removalists' fees and two sets of disconnection and reconnection fees for utilities can add up to a surprisingly large amount.
A less obvious cost is the potential loss of return on the equity you had in your home. Say you have $50 000 in the bank after your old home is sold. If you invest this sum in a cash management account, it could earn five per cent interest. But if property prices in your area are rising by an average of 10 per cent each year, you will effectively lose half the return that you could have achieved if your money were still invested in bricks and mortar. Of course, the converse is also true. If property prices stagnate or slump, you may get more on your capital if it is invested outside of real estate.
The alternative scenario of buying a new house before you have sold your existing property has its own set of attractions and risks. Owning the two properties simultaneously means that you can move from one home to the other at your own convenience. However, it is also a riskier prospect than selling before you buy.
If it takes longer than you had anticipated to sell your old home, you may find yourself struggling to pay off two mortgages simultaneously. If this becomes an unbearable pressure, you might end up selling your home for less than you had intended, leaving you with a bigger debt on your new property. The decision of whether to sell then buy or buy then sell should therefore be made with a careful eye on what is happening in the property market. If demand is strong in your area, you will likely find a buyer within an acceptable time frame without having to lower the asking price on your home. This factor greatly reduces the risk of buying before you sell.
A strategy of buying before you sell can also cause some financing problems since you will usually need short-term credit to purchase the new property. If you can arrange to settle the sale of your old home prior to settling the purchase of your new home, you will still need to come up with the deposit required when contracts are exchanged. This cost can be covered with a deposit bond, short-term credit or bridging finance.
A deposit bond is a document that guarantees a property vendor will receive the purchaser's deposit at the time of settlement rather than on exchange of contracts. Deposit bonds are issued by companies that promise to provide the vendor with the deposit amount if the borrower pulls out of the deal prior to settlement. The bond issuer then pursues the purchaser for the sum of the deposit. Deposit bonds usually cost a borrower something over one per cent of the deposit total, making them an extremely affordable option by comparison with short-term finance, such as putting the deposit on credit card or taking out a personal loan. They also have the advantage of giving the purchaser the use of the deposit sum in the lead-up to settlement.
Bridging finance is another means of covering the gap in finance between purchase of a new property and sale of an old one. Bridging loans cover the entire cost of your new purchase on the basis that some or all of this debt will be extinguished when the old property is sold. The loan is secured by both properties.
Since your debt now covers the cost of the new home as well as the balance owing on the old, your repayments are going to be significantly higher. Some bridging lenders will capitalise the repayments on your new home during the relocation period. That is, they will tack them onto the debt you will owe after paying out your original loan so that you are not suddenly hit by a massive hike in your monthly expenditure.
If the sale of your old property does not extinguish the debt on your new home, you have what is known as an 'end debt'. In general, bridging finance for the end debt has lower fees than bridging finance that is fully paid out after selling. This is because the bridging loan is over a short period, which means the lender does not have time to accumulate much interest on the deal.
The already tricky decision regarding moving house is further complicated by the question of switching loans. Broadly speaking, the borrower has two options. He or she can refinance with the same lender or pay out the existing loan and assume a new mortgage with another lender.
If your loan is 'portable' your lender will allow you to take your loan to a new property, usually upon payment of a moderate fee. If not, you will need to pay out your existing loan and negotiate a new facility. In this case you may be subject to exit fees or break costs.
Mortgage analysts often suggest that mortgages and marriages are similar. And sure enough, when the spark has left the relationship with your lender, it is not just a matter of parting with a gentle kiss on the cheek and a murmured apology. Far from it. You may have to pay your lender substantial alimony. Lenders term this an 'exit penalty', the 'early repayment interest adjustment' or a number of other euphemisms.
These can all be placed under the general title of 'break costs', an expression which gets the point across very well. If you exit a fixed-rate mortgage, you break a contract with your lender. The lender will therefore expect you to compensate them for any losses which the break entails.
Borrowers often fail to realise that funds lent to them at a fixed rate of interest represent an ongoing cost to lenders. In many cases, a lender's profit margin on an individual loan can be comparatively slender. Whether the finance is sourced from bank deposits or by issuing bonds, the lenders' cost of funds can be high enough to make some fees non-negotiable. Break costs cover a potential loss to the lender and are very seldom written off.
Under the Uniform Consumer Credit Code (UCCC) lenders are not permitted to charge exorbitant or punitive break costs. Despite this, break costs charged to a borrower can sometimes be very hefty indeed and are occasionally hefty enough to outweigh the overall benefit of changing loans.
The bottom line
The process of moving houses and switching loans can be both a satisfying lifestyle choice and a smart financial move. However, it can also be risky. Home owners should make sure they are aware of the likely risks and benefits before making their choice. Use the ready reckoner below to estimate your net cash flow if you were to buy then sell or sell then buy.
Calculating Break Costs
The calculations used to determine the break cost charged can be complex and tend to differ from lender to lender. Some lenders base their calculations on the initial loan amount while some use the amount outstanding when you leave the loan. Other lenders calculate the cost on the basis of the original period of the loan, and others on the period remaining for repayment.
The fundamental basis of most calculations is the interest rate payable for the period from the date of repayment to the end of the fixed term. This interest rate can be worked out one of three ways, each of which represents a different amount:
- The difference between the original interest rate of your loan and the interest rate for a loan of the remaining period.
- The difference between the lender's cost of funds at the time of the loan agreement and at the time of repayment.
- The difference between the original interest rate of your loan and the cost of funds at the time of repayment
"Buy then Sell/Sell then Buy" Calculator
This calculator will give an indication of the costs you will face depending on whether you buy then sell or sell than buy a new home. The calculator supplies broad indicative estimates rather than figures which will be precisely accurate for every case. It attempts to capture the costs associated with the timing of the purchase and the sale, not details. For example, this estimator does not take into account the mortgage break costs which may be payable when a loan is paid off before completing its agreed term as these costs are determined by each lender differently and relate specifically to each individual case.