Favourable Purchase: What is it?
A favourable purchase is a bank term for what they call a transaction where a property is sold “off market” and under “market value”. Off market means without a real estate agent involved so the buyer and seller either know each other or it’s a private sale. Under market value refers to the situation where the seller is not selling the home for what the property is worth and are therefore in essence gifting the purchaser equity.
The most common example is where mum and dad may be retiring or looking to move or downsize and will want to sell the family home. Sometimes the children decide they would like to purchase the property off their parents. The parents will then sometimes sell the property to the kids for a price less than what they could sell on the open market to help their kids out or keep the home in the family.
This is a favourable purchase and different Australian lenders apply different policy on this issue.
How do the banks view a favourable purchase when approving a home loan?
It is important to distinguish a favourable purchase from a sale where the buyer believes they are getting a great deal and buying the property at well below market value. Banks will always lend and base their LVR and deposit requirements on the lesser of the contract of sale price or the valuation unless an exception applies. If for example you purchase a property for $500,000 and the valuation did come in higher at $550,000, the bank will base their LVR and deposit requirements on the lesser of the two, in this case the purchase price of $500,000. If however the valuation came in lower than the purchase price then the banks will base it on the lower of the two being the valuation.
Just stating that you have got a great deal is not sufficient to get the bank to make an exception to the rule and base their deposit and LVR on a valuation that came in higher. There must be a compelling reason why the vendor is selling under market value – the fact they are going bankrupt or it’s a deceased estate is not a compelling reason as, theoretically, what you are paying is market value as that is what the market has deemed the property worth on that given day.
The primary reason why the bank would make an exception is where a favourable purchase is involved. If parents are selling to children the banks understand that there is a reason there, essentially being for love and affection, why the parents are selling below market value. The result is that many lenders will base their LVR and deposit requirements on the actual valuation and not the purchase price.
So what does this mean to me and how much deposit will I need?
When purchasing a home in Australia and getting a home loan you need a deposit. Generally the absolute minimum deposit you would require would be 5% and the bank would then loan you the other 95% of the purchase price.
In a case of a favourable purchase, some banks will actually see the gift equity as your deposit. For example, if you were purchasing a property from your parents for $400,000 that was valued at $500,000, some banks will view the $100,000 gifted equity there as your deposit and therefore you can borrow the entire $400,000 without having to put in any deposit of your own.
Every bank has their own policy on this with some only lending against the actual purchase price – ie, they might only lend 95% against the $400,000 purchase price or will only lend to a maximum of 80% of the valuation. But there are lenders that will lend the full 100% of purchase price plus costs up to 90% of valuation without the client having to put in any cash of their own.
Here is another example to illustrate how the different bank policies work:
Assume David was going to buy his grandmothers property so his grandmother could move into a retirement home. The property valued at $300,000 and his grandmother needed $270,000 to ensure she had enough to pay the accommodation bond etc. So the purchase price was below market value at $270,000 and it is between related parties. The banks will deem this a favourable purchase.
The bank will base the LVR/Deposit on the purchase price of $270,000. This particular lender required a 10% deposit which is $30,000. $300,000 less $30,000 leaves a loan amount of $270,000 which means that David could borrow 100% of the purchase price and would only have to pay for his stamp duty and legal costs.
Another lender though will only lend to 80% LVR. 80% on $300,000 is $240,000. If David went to this lender he would need a 20% deposit which is $60,000. $30,000 is available in equity and therefore David would need to contribute $30,000 of his own cash plus stamp duty.
Every lender has their own policy on favourable purchase home loans so it is recommend you engage a mortgage broker who has experience in favourable purchases.