For many of us, buying and selling our first property can be confusing.
Why all the strings attached? Why the need for conveyancers and solicitors? Can’t I just sign on the dotted line and transfer the money?
All this talk of “encumbrances”, “caveats” and “discharges”. What does it all mean?
Understanding a mortgage is key to getting them to work for you. So let’s take some of the mystery out of buying that first home or investment property.
First, a little history.
50 years ago, a mortgage was once-in-a-lifetime commitment to secure the family home. Today, we’re more likely to be investors, taking on multiple loans to build wealth through equity and rental income.
Back in the good old days, when a mortgage was something you negotiated with your bank manager over dinner, a few extra hoops to jump through wasn’t a problem. Today, you need to strike while the market is hot, which can make all the additional work seem inconvenient.
It might take longer than we’d like, but buying and selling property comes with built in protections, for you and your bank.
These protections – and the need for expert advice – are even more important than ever.
So how does a mortgage work?
When you take out a mortgage, a lender (such as a bank) buys a property on your behalf, committing to sell that property on to you in the form of a loan. Given the lender takes on the risk of this purchase, they want to make sure their investment is safe.
This is the “mortgage”; a loan with additional protections in place to protect the lender. The most obvious of these protections can be found on the official government title for your house, where the name of your bank is listed as the mortgage holder. This is called an “encumbrance”. It’s basically a signal to the world that the property is owned by the bank and subject to a loan.
Why should a mortgage be listed on the title?
It’s an extreme hypothetical, but imagine you got the opportunity to buy a house worth $350,000 for $100,000 cash. A quick search of the title would show the house is subject to a mortgage, meaning there’s probably a debt attached to the property than the seller is concealing, and that debt needs to be settled before the house can be sold.
So does that mean you can’t sell a house when there’s a mortgage? Of course you can.
Even though your lender owns the property, you still have the right to sell that property under the terms of your mortgage. But, as you’d expect, when you sell the bank gets paid first.
This is called a “discharge of mortgage”. This means the bank gives up its rights over the property, allowing you to sell it, in exchange for a cash-settlement of the outstanding loan amount.
Who can arrange a discharge of mortgage?
First thing you need to know – a discharge of mortgage takes time. A few weeks, usually. It’s a legal process and requires forms and the services of a licenced conveyancer or solicitor, like at Welden & Coluccio Lawyers.
The discharge will need to be arranged before you sell your home. This basically frees you up to come to the bargaining table for a sale and shows the other side that you’ve got permission from the bank to sell your home.
Once you’ve lodged your discharge of mortgage application, the lender will speak with your solicitor or conveyancer and arrange to be present at “settlement”. This is where money is exchanged and the sale or purchase of property formalized.
Settlement usually takes place online, but occasionally your conveyancer or solicitor will still have to attend a formal settlement in-person, where discharge documents and cheques are exchanged with other banks and conveyancers (it’s really something to see – like a cattle market at times).
From there, the lender will then generally register the discharge of mortgage at the Land Titles office to show they no longer hold an interest in the property.
It can be a slow, cumbersome process, but it works and is pretty well-designed to prevent fraud.
There are often fees involved in discharging a mortgage, including a discharge fee and, if you have a fixed rate loan, potentially costs associated with breaking your loan. Some lenders also charge a fee for paying off your home loan very early, say within the first three to five years. They’ll usually add these fees to the amount they take from your sale.
What happens next?
So the house is sold, you’ve discharged your mortgage. Congratulations! But, it’s not all profit yet. As you’d imagine, you also need to pay any outstanding bills for the property you’re selling. Think rates, water and other utilities etc.
There could also be fees associated with paying off your mortgage early which have to be taken into account, along with the professional fees for your solicitor or conveyancer.
If you’re not purchasing another property, the balance after all fees have been taken out will usually be transferred into your bank account.
If you are buying another property, that money might be held by your bank or solicitor to put towards another property. Or, if you’ve arranged simultaneous settlement, the bank will automatically put that money towards a new mortgage.
What happens if you come up short?
While negative gearing can be a good thing for property investors, losing money isn’t ideal when it comes to selling a home.
Remember, when you take on a mortgage, you not only have to pay off the principal loan amount, but the interest too.
Selling a property for less than you owe is called Negative Equity, and it could mean having to sell other assets to pay-out the bank. Think your car, another house …
And it’s not just those bad with money who might face this possibility. It’s common for people to get sick or injured and fall behind on loan payments.
Obviously, being in a negative equity situation isn’t great. For this reason, we always suggest those facing a difficult decision with regard to their home consult a suitably qualified solicitor or accountant to get the best advice. Sometimes an innovative solution can be negotiated.
Enlist the expertise of an experienced solicitor or conveyancer to oversee your property transactions. That way, the selling process is more likely to run smoothly and especially in the case of solicitor, they can advise you of the best ownership structures to have in place.
You should also see the purchase or sale of a property as a reason to revisit your estate plan and Will.
Your debt doesn’t die with you, so you need to make sure that your children don’t inherit your problems.