You may have come across this term before – “property/security substitution”. Not many people understand much about this or how it comes into play with regards to operating their home loan. As such, we thought we would devote a few paragraphs discussing it.
What does it actually mean? Well, at the most basic level, it means exactly that, ie, substituting the property/security on your home loan. By way of example, you have a home loan for $400k. You used it (and a deposit of $200k) to buy house A which cost $600k. You have now sold house A and have bought house B. You want to keep the same home loan to fund the purchase of house B.
That is the process at its most simple. However, there are various practical matters to consider:
- Is house B worth at least as much as house A?
- Have there been any changes to your circumstances as a result of this “swap” that may affect your ability to continue servicing your home loan?
- Is the transfer of ownership for the sale happening on the same day as transfer of ownership for the new purchase?
The details can get quite complicated – but looking at these points in a little more detail… What your lender wants to make sure of is that the new property provides at least the same amount of security against the home loan as the previous one. So in the example above, if house B is worth (based on valuation) at least $600k, it should be OK to swap. If it is worth less than $600k, the lender would not have the same level of security as it had with house A and as such, some changes to the loan facility may also be required.
Has the sale of the house been driven by some lifestyle change that may impact your ability to service the loan repayments? Let’s say that you have decided to retire and as such, have bought a new house on the beach. Your lender might be concerned that without income, you can no longer service your ongoing loan commitments. As such, they may insist on reducing the loan amount or might refuse the substitution altogether.
The really tricky part is the actual transfer of title. A lender cannot afford to have no security against a loan. As such, you will need to ensure that the new property and the old property are substituted as part of the same settlement process. With various parties involved in both sides of the transaction, this is sometimes difficult to arrange. The lender will not release the existing security until the new security has been transferred to replace it.
MyRate reviews substitution deals on a regular basis to ensure that all the factors are being considered. The key message here is that borrowers should be aware of the complexities surrounding such transactions and should work to meet the requirements of the lender in order to ensure they are not disappointed or delayed.