Auctions can be an exhilarating way to secure your dream property, but they do carry additional risks you need to be aware of.
Whilst you might try to avoid purchasing via auction altogether, often it’s unavoidable – especially if a property you love is being sold that way.
Here we examine the inherent risks associated with purchasing via auction. We also provide some tips help to minimise these risks, so you can give yourself the best chance of securing the property you want without putting yourself under unnecessary financial pressure.
What Makes Auctions Risky?
Unlike buying via private treaty (i.e. non auction purchase), there is no cooling-off period with an auction purchase. Once the hammer falls, if you’re the highest bidder, you’re legally bound to sign the contract and proceed with the purchase right away.
This means there can be:
- No Room for Second Thoughts: You can’t change your mind after you’ve secured a property at auction. If you discover issues with the house after the auction, or the valuation comes in low, you’re still legally obligated to proceed with the purchase.
- Deposit Pressure: You’ll need to pay a deposit immediately after winning the auction. Most vendors/agents will allow a 5% deposit to be paid on Exchange for an ACT purchase, but it’s important to remember you’re still liable for 10% of the purchase price if you can’t follow through to settlement.
- Overbidding in the Heat of the Moment: The fast-paced environment of an auction can sometimes lead to emotional bidding, which pushes the price beyond what you’d planned to pay or can comfortably afford.
While these risks apply to any auction buyer, they’re amplified if your financing is tight.
If you’re seeking a high Loan to Valuation Ratio (LVR) under the 5% Deposit Home Buyer Scheme for example, and already contributing all your cash towards the purchase, there’s no wiggle room if things don’t go to plan post auction.
Let’s look at this scenario closer….
What Happens with a Low Valuation if you’ve Applied for a 95% Loan to Value Ratio (LVR) Loan
A 95% LVR pre-approval means you’re planning to borrow 95% of the property’s value, and contribute as little as 5% as the total cash contribution towards a property (plus additional costs to cover solicitor fees etc). Whilst the scheme can make homeownership more accessible, it’s important to understand the implications of seeking a high-LVR loan for an auction purchase.
The LVR is calculated as the loan amount, divided by the lower of the purchase price or the property value. The property value is typically confirmed by a bank-ordered valuation as part of the Full Approval assessment process.
In the majority of cases, the valuation will confirm the auction purchase price – because what better way to determine the market of a property than the market itself via an auction! However, this outcome is not guaranteed.
With an auction purchase, the valuation happens after the auction (i.e. AFTER you sign the contract and legally commit to purchase a property). So, if there’s an issue with the valuation or it comes in lower than the purchase price, you won’t know about this until after you have legally committed to purchase the property.
With a private treaty purchase (i.e. non auction), the valuation occurs after your offer has been accepted but before you sign the contract. With a low valuation in this scenario, you still have the option to pull out of the sale (or renegotiate the price) because you haven’t yet signed the contract.
How can a Low Valuation Impact your Loan?
Let’s run through an example:
You’re pre-approved for a 95% loan of $760,000. Along with your $45,000 cash contribution, this new loan of $760,000 will facilitate a purchase up to $800,000. (We’ve assumed you have a stamp duty waiver as a first home buyer and purchasing costs of approx $5,000.)
Let’s say you secure a property at auction for $800,000, but the valuation conducted post auction says the property is worth $790,000.
You might be pre-approved for a loan of $760,000, but the lender will now only lend a maximum of 95% of the valuation figure – i.e. 95% of $780,000 – which results in a loan amount of $750,500. You still need a total of $805,000 to complete this purchase, so now need to contribute a total of $54,500 cash towards the purchase.
If you don’t have an extra $9,500 cash you can contribute towards the purchase (and there’s no other options available – which we outline here), the purchase could fall through. In which case, you’re at risk of being liable for 10% of the purchase price (i.e. more than the $45k cash you currently hold).
How to Mitigate the Risks Associated with Purchasing at Auction
There are some steps you can take to minimise the risks associated with purchasing via auction:
- Get a Strong Pre-Approval: Ensure your pre-approval is in place before auction day.
- Research Thoroughly: Attend other auctions, review comparable sales of similar properties and consider setting a bid limit below the maximum price you’re pre-approved for.
- Build in Contingencies: If possible, have backup funds or family support ready for any unplanned shortfalls.
- Have your solicitor review the contract before auction day: Have your conveyancer review the contract pre-auction to ensure there are no untoward clauses you shouldn’t agree to. If there are inclusions that need to be noted on the contract, ensure these are added to the contract before the auction day.
- Arrange any additional inspections you wish to: If the building and inspection report flags potential issues that warrant further investigation, you need to look into this before the auction day.
- Negotiate the settlement timeframe: We typically recommend you negotiate a longer settlement than the standard ‘30 days’ because some of this timeframe is used to get your loan approved. Talk to us about this as you’re getting ready for an auction, because the recommended timeframe will depend on the lender your pre-approval is with and their processing times at the date of the auction etc.
Auctions aren’t for everyone, but with the right preparation, they can be a good way to secure your new home.
