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The Devastating Consequences of Failing to Secure Finance Approval

What Property Buyers Need to Know About the Contract for Sale #32: What are the consequences of failing to obtain finance approval?

Introduction

Obtaining finance approval is a crucial step in any property purchase. In New South Wales (NSW), failing to secure the necessary financing can have significant legal and financial consequences for the buyer. This section explores what happens when a buyer fails to obtain finance approval, the potential repercussions under NSW law, and the steps buyers should take to mitigate risks and avoid penalties.

Understanding Finance Approval and Its Importance

Finance approval refers to the formal approval from a lender (such as a bank or financial institution) to provide the funds necessary to complete a property purchase. This approval is typically based on the buyer’s financial circumstances, the value of the property, and the prevailing market conditions. Securing finance approval is essential for several reasons:

  1. Contractual Obligation: Most property contracts in NSW are conditional on the buyer obtaining finance approval by a specified date. Failing to meet this condition can result in the contract being terminated or voided.

  2. Risk Management: Finance approval provides assurance to both the buyer and seller that the buyer has the necessary funds to complete the transaction, reducing the risk of default.

  3. Market Conditions: In a competitive property market, having finance approval can strengthen a buyer’s position, enabling them to move quickly and confidently.

Legal Consequences of Failing to Obtain Finance Approval in NSW

Failing to secure finance approval can lead to several legal consequences under NSW property law:

  1. Contract Termination: If a buyer does not obtain finance approval by the agreed-upon date, the seller may terminate the contract. In such cases, the seller is typically entitled to retain the deposit paid by the buyer as compensation for the failure to proceed with the sale.

  2. Loss of Deposit: In NSW, property deposits are usually 5-10% of the purchase price. If the buyer fails to obtain finance approval and the contract is terminated, the seller may be entitled to keep the deposit. This can result in a significant financial loss for the buyer.

  3. Potential Legal Action: The seller may pursue legal action to recover additional damages if they believe the buyer has acted negligently or in bad faith by entering into a contract without securing adequate finance.

  4. Credit Rating Impact: Failing to obtain finance approval and subsequently defaulting on a contract can negatively impact the buyer’s credit rating, affecting their ability to secure loans in the future.

  5. Penalties for Contract Breach: If the buyer fails to notify the seller about the lack of finance approval and attempts to delay the process, the seller may impose penalties for breach of contract. These penalties can include interest on the unpaid purchase price, legal costs, and compensation for any financial losses incurred by the seller.

Practical Steps to Mitigate the Risks of Failing to Obtain Finance Approval

To avoid the serious consequences associated with failing to obtain finance approval, buyers should consider the following steps:

  1. Obtain Pre-Approval: Seek pre-approval from a lender before making an offer on a property. This provides a preliminary indication of the amount that can be borrowed, helping to guide the buyer’s search for a property within their financial means.

  2. Set Realistic Timeframes: Negotiate realistic timeframes for finance approval in the contract of sale. This allows sufficient time for the lender to process the application and for the buyer to provide any additional documentation required.

  3. Communicate with the Seller: If there are delays in obtaining finance approval, the buyer should communicate openly with the seller and their agent to discuss potential extensions or alternative arrangements.

  4. Include a Finance Clause: Ensure that the contract of sale includes a finance clause that allows the buyer to withdraw from the contract if finance is not obtained by a specified date. This can help protect the buyer’s deposit and minimize legal exposure.

  5. Seek Professional Advice: Consult with legal and financial professionals to understand the implications of failing to obtain finance approval and to ensure that all contractual obligations are clearly defined.

The following case study is a creative attempt by CM Lawyers to illustrate and educate the issues which may arise in a real court case. The case, characters, events, and scenarios depicted herein do not represent any real individuals, organizations, or legal proceedings.

Case Study: The Impact of Failing to Obtain Finance Approval in NSW – A Costly Default

Case Overview

In the case of Johnson v. Patel [2022] NSWSC 341, a buyer’s failure to obtain finance approval led to a costly legal battle and significant financial losses. The property, a four-bedroom house in Newcastle, was purchased for $900,000. Mr. Johnson, the buyer, entered into a contract with a 10% deposit ($90,000) and a finance clause that required him to obtain loan approval within 21 days.

Behaviour of the Participants

Mr. Johnson was initially confident in his ability to secure financing, having received verbal assurances from his bank. However, due to unforeseen changes in his financial circumstances, his formal loan application was declined. Instead of notifying the seller immediately, Mr. Johnson attempted to secure alternative funding from private lenders, which proved unsuccessful. As the deadline for finance approval passed, the seller, Ms. Patel, grew increasingly frustrated by the lack of communication and transparency.

Fearing that the sale might fall through, Ms. Patel began looking for alternative buyers. When she eventually discovered that Mr. Johnson had failed to secure finance, she terminated the contract and sought to retain the deposit. Feeling desperate and overwhelmed by his situation, Mr. Johnson attempted to negotiate a partial refund of the deposit, but Ms. Patel refused, citing the costs and inconvenience caused by the delay.

Legal Process and Court Involvement

The case was brought before the NSW Supreme Court after Mr. Johnson filed a suit seeking the return of his deposit, arguing that he had acted in good faith and had made every effort to obtain financing. Ms. Patel countered that Mr. Johnson had breached the contract by failing to notify her promptly of his inability to secure finance and by not meeting the conditions outlined in the contract.

The court found in favor of Ms. Patel, ruling that Mr. Johnson had failed to comply with the terms of the contract and that his lack of communication constituted a breach of contract. The court allowed Ms. Patel to retain the $90,000 deposit and awarded her an additional $15,000 in damages to cover the legal fees and costs incurred due to the delay.

Financial Consequences

Mr. Johnson faced substantial financial consequences, losing the $90,000 deposit and incurring additional legal fees of approximately $20,000. His credit rating was also adversely affected, impacting his ability to secure future loans. For Ms. Patel, while she retained the deposit and was awarded damages, the delay in finding another buyer and the cost of legal proceedings resulted in significant stress and additional expenses.

Statistics

  • Deposit Losses: In NSW, approximately 10% of property transactions involve disputes over the return of the deposit due to failure to obtain finance approval.

  • Legal Costs: The average cost of legal proceedings in finance-related property disputes in NSW ranges from $15,000 to $50,000.

  • Contract Default Rate: Around 8% of property contracts in NSW are terminated due to buyers failing to secure finance approval.

  • Impact on Credit Ratings: Buyers who default on property contracts due to lack of finance approval may see their credit scores drop by 50 to 100 points.

  • Pre-Approval Rates: Approximately 60% of buyers in NSW seek pre-approval before making an offer on a property.

  • Finance Clause Usage: Nearly 90% of standard property contracts in NSW include a finance clause to protect buyers.

  • Timeframes for Approval: The average time for obtaining finance approval in NSW ranges from 14 to 28 days.

  • Deposit Amounts: Typical property deposits in NSW range from 5% to 10% of the purchase price.

  • Dispute Resolution Time: Resolving finance-related disputes in NSW courts takes an average of 6 to 12 months.

  • Buyer Protection Rates: Buyers who include a finance clause in their contracts have a 95% success rate in recovering their deposit if finance approval is not obtained.

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