Buying a house from parents or grandparents – can I get a house loan for a cheap purchase?

Cheap buy: what is it?

Bargain purchase is a banking term for what is known as a transaction in which a property is sold “off market” and below “market value”. Off-market means that there is no real estate agent involved, so the buyer and seller either know each other or it is a private sale. Below market value refers to the situation where the seller is not selling the home for the property’s value and is therefore essentially giving the buyer equity.

The most common example is when a mom and dad want to retire or relocate or downsize and want to sell the family home. Sometimes the children decide that they want to buy the property from their parents. The parents then sometimes sell the property to the children at a price below what they could sell on the open market in order to help their children or to keep the home in the family.

This is a cheap purchase and different Australian lenders apply different policies on this matter.

How do the banks view a bargain purchase when approving a home loan?

It is important to distinguish a bargain purchase from a sale where the buyer thinks they are getting a lot and are buying the property well below market value. Banks always lend and base their LVR and deposit requirements on the lower of the sale contract price or valuation, unless an exception applies. For example, if you buy a property for $500,000 and the valuation is higher at $550,000, the bank will base its LVR and deposit requirements on the lower of the two, in this case the $500,000 purchase price . However, if the valuation is lower than the purchase price, banks will assume that the lower of the two is the valuation.

Merely noting that you have a good deal is not enough to make the bank make an exception to the rule and base their deposit and LVR on a higher rating. There must be a compelling reason why the seller is selling below market value – the fact that they are going bankrupt or it is an estate is not a compelling reason as you are theoretically paying market value as the market has assumed the value of the property on that particular day.

The main reason the bank would make an exception is if it’s a cheap purchase. When parents sell to children, the banks understand that there is a reason, essentially love and affection, why the parents are selling below market value. The result is that many lenders base their LVR and deposit requirements on actual appraisal rather than purchase price.

What does this mean for me and how much deposit do I need?

When you buy a house in Australia and get a home loan, you need a down payment. Generally, the absolute minimum deposit you need is 5%, and the bank would then loan you the other 95% of the purchase price.

In the case of a cheap purchase, some banks actually treat the gift capital as your deposit. For example, if you bought a property from your parents for $400,000 that was valued at $500,000, some banks will consider the $100,000 as your deposit and therefore you can use the entire $400,000 borrow without having to deposit your own money.

Each bank has its own policy on this, with some only lending against actual purchase price – ie they may only lend 95% of the $400,000 purchase price or only lend a maximum of 80% of the value. But there are lenders who will lend 100% of the purchase price plus costs up to 90% of the appraisal without the customer having to put any money of their own.

Here’s another example to illustrate how the different banking policies work:

Suppose David bought his grandmother’s property so that his grandmother could move into a retirement home. The property was valued at $300,000 and his grandmother needed $270,000 to ensure she had enough to pay the bail for housing etc. The purchase price was therefore below market value at US$ 270,000 and is between related parties. Banks will see this as a cheap buy.

The bank will base the LVR/deposit on the purchase price of $270,000. This particular lender required a 10% down payment of $30,000. $300,000 minus $30,000 equals a loan amount of $270,000, which means David could borrow 100% of the purchase price and only have to pay his stamp duty and legal fees.

However, another lender will only lend up to 80% LVR. 80% on $300,000 is $240,000. If David went to this lender, he would need a 20% down payment, which equals $60,000. $30,000 in equity is available and therefore David would need to contribute $30,000 of his own cash plus stamp duty.

Each lender has their own set of policies for cheap home loans, so it’s a good idea to use a mortgage broker who has experience with bargain buying.