Buying off the plan: pros and cons and how to pay your deposit

Many people, home owners and investors alike, see buying off the plan as a good way to purchase a brand new property. However, as with any investment, there are pros and cons to consider when buying off the plan.

What is buying off the plan?

Buying off the plan means buying a property that hasn’t been built yet or is still under construction. You make your decision to buy based on the building plans and designs, rather than the finished product.

Pros and cons of buying off the plan

There are some key differences when buying an off the plan property compared to buying an existing property, and each difference has its own set of benefits and risks to consider.

The property hasn't been built yet

As the property has not been finished, you may have more flexibility than if you were buying an existing property. Of course, there are also risks involved.

Pros

• Purchase price discount

If you get in early enough, particularly before construction begins, the developer may offer a discount on the purchase price. 

• Input into design

You might have the opportunity to negotiate changes to the interior style of the property. Check with the developer to find out what’s possible. 

• Builder's guarantee

New properties generally come with a builder’s guarantee. How the guarantee works and what it covers may be different depending on the state or territory where the property is located, so check this carefully to see if a guarantee is available and how it could protect you.

Cons

• May not meet your expectations

When you buy off the plan, you don’t get a chance to ‘walk through’ the property before you buy it, so it might turn out differently to what you expected.

• Possible construction delays

If the building isn’t completed on time, there may be increased costs or inconvenience, such as if you need to continue renting until the property is ready.

Your deposit and potential government concessions

When buying an off the plan property, there are some considerations around your deposit and government charges that you should take into account.

Pros

• Time to save more money
  When you buy off the plan, you may need to pay a deposit when signing the contract of sale (more on this below). The balance of the purchase price for the property is paid at settlement (when construction is finished). This gives you from signing the contract until settlement to save more money which you could put towards reducing the amount you need to borrow, stamp duty or other upfront costs.

• Potential to earn interest on your deposit

Your deposit may be held in a trust account until after completion and in some instances, you may earn interest on the cash deposit you've paid until settlement. Alternatively, the developer may agree to let you secure the purchase using a deposit guarantee from your bank. This could allow you to keep earning interest on your funds while your home is being built. Different rules can apply depending on the development, so find out more about how it works for the property you’re looking at.

• Stamp duty savings

In some states and territories, you may be able to save on stamp duty because you’re buying a new property. This can vary depending on which state or territory the property is in, whether you’re purchasing a home or an investment property, and your particular contract. Check with your conveyancer or solicitor about the stamp duty owed, whether any concessions are available, and when it must be paid.

• Tax benefits for investors

If you're buying for investment purposes, you may be eligible for tax benefits if you're buying off the plan. Tax rules are complicated, so check this with your accountant or registered tax agent.

• First home buyer concessions

If you’re buying your first home, you could be eligible for the First Home Owner Grant (FHOG). You don’t necessarily need to be buying off the plan to be eligible but they’re worth bearing in mind when weighing up your options. Rules and grant amounts vary depending on the state or territory, so check your eligibility carefully.

Cons

• Builder bankruptcy and your deposit

If the developer goes bankrupt before completing the project, you may not get your deposit back. This will depend on the terms of your contract.

Market conditions may change between signing the contract and settlement

Changes in property values, interest rates and your income could affect your financing options.

Pros

• Capital growth

There’s potential for the property to increase in value during the course of construction.

Cons

• Changes to interest rates or income

Higher interest rates or changes to your income could affect how much you can borrow or the repayments you can afford to make.

• Lower property value

Your lender will only value the property at completion and sometimes the final value may be less than you expected. This in turn may affect your loan to value ratio (LVR), which is the amount you need to borrow calculated as a percentage your lender’s valuation of the property. More on this below.

• Lower resale value than expected

If you’re buying the property as an investment, bear in mind that during the time it takes to build the development, market fluctuations and other housing developments may affect its resale value.

• Your financial situation and/or lending policies may change between signing the contract and construction finishing

If circumstances change before your final application is approved, whether they be your personal income or the wider economic environment, you may not be able to borrow the amount you were pre-approved for which could leave a shortfall.

Your deposit when buying off the plan

We’ve already discussed that when you buy off the plan, you may need to pay a deposit (commonly between 5% and 20%) when signing the contract of sale. 

Let’s unpack things a bit more...

Let’s say your property’s value goes up while it’s being built. This would be good news because your loan to value ratio (LVR) may go down.

Your LVR is important because it will affect whether you need to pay the added cost of Lenders Mortgage Insurance (LMI) on your loan. LMI is insurance you pay for, but which protects the bank (not you) if you default on your loan and the money from selling your security property is not enough to repay your loan. 

As a rule of thumb, the lower your LVR, the better.

How LVR could affect your deposit

Let’s use an example to help explain how things work. To keep things simple, we've left out some of the fees and costs you may have to pay when buying a house.

• Let's say you agree to purchase a property for $500,000.
• You have a deposit of $100,000, meaning you need to borrow $400,000.
• This means your current LVR is 80% (i.e. your loan of $400,000 divided by the property value of $500,000).

Two years later, when it's time to settle:

• The property’s value has gone up in value to $550,000.
• Even if you still need to borrow $400,000, your LVR will go 80% to around 73%.
• This is because $400,000 is only 73% of the current property value.

On the flip side, if the property value falls from $500,000 to $400,000, your LVR will go up. If you haven’t saved significantly more for your deposit, this may affect the likelihood of you getting a loan, or it could mean having to pay for LMI if you do get a new loan.

LVR is important so make sure you understand how it works. 

Saving a deposit when buying off the plan

The big question is: How do you come up with enough money for the deposit (plus upfront costs and fees)? For an off-the-plan property worth $750,000 and a 10% deposit, that means your deposit is $75,000. We’re not talking loose change here.

In most cases, lenders won’t let you borrow the deposit amount as part of a home loan. You’ll need to find the money yourself.

Here are some of the ways first home buyers may come up with the money:

• Save more money. Read our tips on saving for a deposit.
• Borrow from family. You could ask a family member for a loan. If you receive a cash gift or borrow from your family, you may still have to prove evidence of your own savings when you apply for your home loan.

Every person’s situation is unique, so be realistic about what you can afford. And be careful about borrowing from family and friends, as you don’t want to end up in a dispute with them if things go wrong.

Some final tips to consider

• Spend some time researching the developer, builder and architect to make sure they have a good track record.
• Always check with the developer to see if they offer any of the benefits discussed above.
• Find out what the process would be to fix any defects that have been identified when the building has been completed.
• Find out how you’re covered if the developer goes bankrupt before completing the project. 
• Make sure you read the terms and conditions very carefully before signing a contract. It is a good idea to seek advice from a lawyer or conveyancer before you sign so you can understand the costs and risks.