Cannot get bond approval? - use a method that has been in existence since 1981
Conventional purchase of property
Rent to buy
Are conventional methods to buy a property outdated or too restricted since the National Credit Act came into effect?
Purchasers have become increasingly less enthusiastic about buying property since the introduction of the National Credit Act (NCA) and the global financial meltdown. Fewer buyers can meet the stringent criteria requested by the banks when buying a property.
Information obtained from the Deeds office shows that the Western Cape, which represents 27% of the national registrations, had in 2007 average monthly registrations of 12 500 transfer registrations and 11 500 bond registrations, while in 2009 the monthly average for transfers had been reduced to 6 500 and to 3 500 for bond registrations, in 2010 the trend continued.
If you have the cash-flow per month, but your credit rating falls short, there is a way to secure a property right now - when property prices are at all time low, with the added advantage that you will be able to build up a track record and a good credit rating; secure finance and then start paying for your new property in two years' time.
Let us first investigate and compare the different methods of buying a property.
Purchasing a property with a Deed of Sale, Offer to Purchase or Sale Agreement. These documents are all the same, the idea is to secure a property with an agreement between the seller and the purchaser; pay a deposit to show your "good intent" and then arrange the finance to pay; either have the cash available; or apply for a loan from a bank which is usually approved within 14 - 21 days from date of application.
Due to the implementation of FICA and risk management control of banks it has become very difficult to obtain a loan from a bank. Almost 50 % of all bond applications are turned down as per the latest ooba barometer, mainly due to a lack of a deposit available by the purchaser, (few Banks are granting 100% loans); lack of affordability combined with the so called "one third of bond repayment vs. income" yardstick, the latter is not a requirement under the NCA, but is nevertheless also applied by the banks; and low credit rating, quite often due to a slow payment history or non-payment of certain accounts or over indebtedness.
Once the bond is approved, the registration process will proceed and the registration of the property in the name of the purchaser ought to be concluded within 2 months.
The positive side for the seller is that he may receive the proceeds of the sale within 3 months after the Deed of Sale is signed.
The positive aspect for the purchaser is that he will own the property and enjoy the value growth of the property, should it increase. The negative aspect is that he will have few "escape" opportunities once the Deed of Sale is signed and may end up being tied to the property until he sells it in the future as it usually takes 20 -30 years to pay off a mortgage loan. If the purchaser realizes that he made a bad investment, his monthly installment and other expenses like rates and taxes may be much higher than renting the same property, or if he cannot afford the monthly installments or needs to relocate due to reasons out of his control, he must find another buyer who is willing to purchase the property and then relieve him of his 20 -30 year commitment.
When the property is sold, the money paid towards interest and capital repayment of the bond, maintenance expenses, cost of transfer, estate agents commissions and taxes must be deducted from the proceeds, and extra expenses must be compared to the expenses should he rent the property at a much lower monthly expense as a tenant.
As from 1981 Instalment Sales were introduced by the Alienation of Land Act, No 68/1981 ("the ALA"). Here the seller and purchaser agree in writing to sell and buy the property, but rather than approaching a bank for finance, the seller grants the purchaser the opportunity to pay off the purchase price and interest over a period of time. This agreement must comply with certain requirements as regulated in the Act. As protection for the purchaser and notification to third parties, this agreement is registered against the title deed of the property. The purchaser is also protected to some extent should the seller go insolvent or for some reason cannot make the monthly payments. The purchaser can also apply for an early loan from a Bank during the repayment period and then use the funds available to settle the balance of the purchase price when he takes transfer. The positive point for the seller is that he is relieved of the obligation to "carry" the property for the duration of the agreement, the funds he receives will be used to settle his existing mortgage loan , but the negative point is that he must sometimes wait up to 5 years to receive the final payment. The seller must also act as his own collection agent and collect the payments from the purchaser every month.
The positive side for the purchaser is that he secures the property, fixes the price, and does not have to go to a bank to apply for a loan. The negative side of this type of transaction is that it may be better suited for transactions under R500 000.00 as the NCA requires that the lender (seller) must be registered under the NCA for any loan that exceeds R500 000.00. A solution to avoid the impact of the NCA was to introduce a trust as purchaser, as a trust with three or more trustees are exempt from the impact of the NCA.
Until as recently as 23 February 2011 few purchasers wanted to be burdened with the higher rate of transfer duty applicable when a property was bought in a trust as transfer duty was levied on a flat rate of 8 % on the purchase price. The higher transfer duty plus the capital gains tax payable on the re-sale of the property compared to the GCT exemption that is available for a primary residence when the property is re-sold discouraged many purchaser to use a trust as a purchasing entity. Transfer duty interest is also payable 6 months after the agreement is concluded.
A potential negative aspect is that there are few safety measures to ensure that the Seller continues to pay his bond as he only needs to provide a bond statement once every 6 months. As the purchase price and interest is paid over a shorter period, usually between 1 - 5 years, compared to the conventional bond repayment of 20-30 years, the increased monthly repayment required from the Purchaser may also deter many purchasers from taking up this repayment structure.
Now is the time to dust off the ALA sale agreements as the change and reduction of transfer duty payable when a trust purchases a property as from 23 February 2011 opens the door for the ALA sale to be re-introduced as a very attractive method for the purchase of a property (when the purchaser cannot obtain bond approval).
The reduction of transfer duty makes this transaction very attractive, if combined with an ALA sale. The purchase of a property by a trust with a value of R1 million now means a saving of transfer duty of R68 000.00, compared to when a trust paid a flat fee of 8% transfer duty calculated on the purchase price. On the purchase of a R600 000.00 property, no transfer duty will be payable, previously it was R48 000.00.
The ALA sale agreement is thus a very attractive method of providing assistance to a buyer with a negative credit record and who cannot obtain a bond approval from a bank, due to his bad credit rating, but who does have the cash-flow to repay the installments as the seller.
The Seller who remains in ownership in fact provides financial assistance to the purchaser to buy the property and the purchaser does not require bank assistance or approval. The Seller receives a good monthly return; will be able to keep his monthly installments on his current bond up to date, paying it back faster, which improves his credit record, and thus can be used to great effect for distressed sellers.
To pay back R500 000 with a fixed 9 % interest rate over:
3 years will cost R 15 899.00 per month
5 years will cost R 10 379.00 per month,
20 years will cost R 4 498.00 per month
This repayment under the ALA structure may make it difficult for many purchasers to achieve, due to the high repayment. However the sooner a debt is repaid the more you "save". Over a 5 year repayment period R622 750.00 in interest and capital are paid back, compared to R1 079 671.00 over 20 years.
Useful tips :
- Use an attorney to prepare your agreement.
- A trust may be a good entity to use as risk mitigation especially if you experienced a problem in the past with debt.
- Ask an accountant to calculate your capital tax repayments if you use a trust, close corporation or company as a purchase entity.
- Make sure you have the affordability to keep up with the repayments.
Rent to buy or lease to own
The seller and purchaser enter into a written agreement and agree that the purchaser will rent the property for a specific period and that he will have the right, without any obligation, to buy the property before the end of the lease period. The recommended lease period is between 6 months and 24 months, but can be longer.
In the current market conditions a tenant pays on average R6 000.00 per month rental to stay in a property worth R1 million rand. In a rent to buy situation the purchaser will pay rental to the seller which is higher than the usual rental, usually 1% of the purchase price per month, thus R10 000.00 on a R1 million rand transaction, so as to include the rates, taxes and levies for the property.
The increased regular payment, showing affordability, stability and creation of a good track record will be used to support the application in future to a bank and prove to the bank that the prospective purchaser meets the affordability criteria and can therefore afford to repay the monthly instalment, as he has paid the rental dutifully, equal to his future bond repayment and other expenses like rates and taxes, over a sustained period of time during the rental period.
To provide even more comfort to the seller, rental administration and rental insurance for rent to own can be introduced to ensure that the seller receives his funds on the first day of each month, secured for three months, should the purchaser default. The insurance will also cover all legal costs should the need arise to evict the purchaser on rental default.
The positive side for the seller is that he secures a committed buyer, receives a higher rental income and the rates, taxes and levies are paid for the duration of the lease period. The rental income can be secured through the rental insurance product.
Should the tenant not exercise the right to purchase the property, the seller retains the rental received and benefit of rates, taxes and levies paid and still owns his property.
If the purchaser exercises the option to buy, a credit, to be used as a deposit, will be allowed to him for the difference in ordinary rental of R6 000.00 per month and the option rental of R10 000.00 paid during the option period. The Purchaser can build up a deposit of up to R4 000.00 per month and can accumulate to R36 000.00 over a 12 month option period. The deposit will improve the chance of success for the purchaser with his new bond application as few banks grant 100 % bonds.
The negative side is that the seller will be tied to the agreement for the full period option period of up to 18 months and can therefore not accept other offers during the option rental period. During such period he however receives a much better rental income and can re-pay his bond faster, which improves his own credit rating. The negative for the purchaser is that the insolvency of the seller jeopardizes the transaction, but with the a proper due diligence that precedes the signature of the option to rent to buy agreement together with the increased rental payments directly into the bond account of the seller, such surprises can be avoided to some extent.
The positive side for the purchaser is that he secures a property when it is the best time to buy a property when it is currently regarded as a buyer's market. But more important he gets the opportunity to build up a track record of affordability and during the lease period he may be able to restore his previous tarnished credit record to prove to the bank, when the bond application is made some months in the future, that he is a client that meets all the requirements of the bank to receive a loan.
It will be of vital importance for the purchaser during the rent to buy option period to use the time as he has 12 or 18 months to re-establish his credit rating, apply to have judgments rescinded to restore his credit record and to pay back unnecessary accounts such as retail accounts and expensive credit card purchases.
The purchaser must realize that he must apply for a bond just before the expiry of the 12 or 18 month rent to buy option period and must prepare himself to meet the affordability, credit rating and deposit criteria of the financial institutions. The purchaser can also make use of established service providers for assistance to negotiate to settle debts, work out a personal budget and adhere to the budget and keep track of every single personal expense, all vital for establishing a good credit record and affordability.
The rental administration and insurance will administer all the payments of the bond account of the seller, rates, taxes and levies, to ensure that monthly payments do not get into arrears. The terms of the contract can also be registered against the title deed, to ensure some level of protection for the purchaser.
The negative side for the purchaser is that he pays a higher monthly rental to secure the lease and opportunity to buy and may not be granted a loan at the end of the lease period, but if he adheres to the program and makes regular payments, he ought to stand a much better chance of obtaining a loan from a bank, compared to a client with an "unproven" track record. The track record of affordability and credit as a deposit that he builds up by paying more rental that his usual rental per month (on a R1 million property usually R36 000.00 after 12 months) will be much to his advantage when he applies for a home loan.
Not every seller may be willing to sell his property with such a delayed transaction, but this method may open up the opportunity to sell for desperate sellers, property investors with few units to sell and property developers with unsold stock. It can also open up the opportunity for investor groups to purchase multiple properties, without raising an upfront bond and the red-tape associated with FICA requirements.
Thus, raising an upfront bond to buy or sell a property may be outdated and an alternative and fresh method ought to explored.
- Use an attorney to prepare your agreement.
- A free tool to calculate your transfer costs, bond costs, bond repayments or capital gains tax from your mobile phone and web link email [email protected] for more information.
- Credit check and debt negotiation http://www.kudough.co.za.
- Extra Tip - you are entitled to a free personal credit check report once per year, but a free credit report might not be adequate - rather pay for a comprehensive report, expect to pay not more than R80.00.
- Avoid too many credit checks as it reduces your credit rating.
- A free tool to capture your personal budget http://www.mobile2budget.com.
- For personal budget education and month to month assistance http://www.budgetfitness.co.za.
- Home Ownership Education - clients such as ABSA, FNB, Integer bank, AngloGold Ashanti Setsmol http://www.setsmol.co.za.
- Rent to buy - http://www.rent2buy.co.za.
- Do you have budget blind spots - Sunday Times Article contact Meyer de Waal [email protected] for a copy.