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How favourable purchases work
Buying a home below market value is called a favourable purchase. It can mean getting a good deal, or even avoiding saving a deposit, but stamp duty is charged on the property's full market value.
Some homebuyers get lucky. They have parents willing to sell their home to them, usually with a bit of a discount. This means the property sells for less than market value. This is called a favourable purchase. It's legal but there is a catch: the government expects the buyer to pay stamp duty on the market value of the property.
What is a favourable purchase?
A below market value sale is one in which you buy a property from a vendor for an agreed price that is below the property’s true market value. Most often, this happens when a parent or family member sells their property for a favourable price. However, there are other circumstances where this could occur.
Some extremely motivated vendors might be willing, or forced, to sell their property below market value. If the vendor is in danger of foreclosure, needs to move quickly on another property, is selling a deceased estate or has had their property listed for a protracted period of time without generating interest, they may sell their home below market value.
Likewise, some vendors may sell a home below market value to cover a debt. For instance, if a vendor owes a sum of money to someone, they may agree to sell their creditor a property at a discounted price in exchange for forgiving the debt.
What are the benefits?
The benefits of a favourable or below market value purchase are pretty clear. If you’re a buyer, you could pick up a property for a highly discounted price. This discounted price can come with some fortunate side effects.
Buying without a deposit
In a favourable purchase, you may be able to buy a property without a deposit. This is because your home loan will be calculated on the property’s true value rather than the purchase price. In essence, you’re being gifted equity in your property.
Here’s how it works:
Say you agree with your parents to buy their property for $400,000. When you apply for a home loan, your lender values the property at $500,000. In this instance, your $400,000 home loan is 80% of the property’s true value. You can pay your parents the full purchase price of the house because the bank considers the gifted equity to be a 20% deposit.
Avoiding lenders mortgage insurance (LMI)
Lenders mortgage insurance, or LMI, is an insurance policy that covers your lender in the event you default on your home loan. LMI is required on home loans where you have less than a 20% deposit. In spite of covering your lender and not yourself, you pay the premium for an LMI policy. This can add tens of thousands of dollars to the cost of your home loan.
However, when you buy a home below market value, you may be able to avoid LMI, even if you borrow more than 80% of the purchase price. This is because, as discussed above, most lenders will calculate your loan-to-value ratio (LVR) on the market value of the property rather than the price you’re paying for it.
Just like in the example above, you could borrow 100% of the purchase price of the home but still have an LVR below 80%.
What are the drawbacks of a favourable purchase?
Unfortunately, the way lenders value a property sold as a favourable purchase can be a double-edged sword. While you’ll get a discount on the purchase price, you won’t get a discount on some of the associated costs.
For example, stamp duty will be calculated on the property’s market value rather than the discounted purchase price. This means you could find yourself in a situation where the purchase price you pay is below the threshold for stamp duty concessions but the market value will be above the threshold. In this case, you’ll still have to pay stamp duty.
Favourable purchase agreements can also impact your eligibility for First Home Owner Grants (FHOGs). Again, while you may be paying a discounted price that falls within the eligibility of your state’s FHOG scheme, the market value of the property may determine whether or not you can receive the grant.
Likewise, if your parents are selling you a property they bought as an investment, they’ll be liable for capital gains tax for the property’s true market value rather than the price at which they sell it to you.
Another potential pitfall is that lenders can be wary of sales below market value. Some lenders are hesitant to lend for favourable purchase agreements, and some lenders mortgage insurance providers have policies that can make such purchases difficult.
However, not all lenders balk at favourable purchases. Some are more than willing to lend without a deposit, so long as the loan doesn’t exceed 105% of the purchase price of the property.
Drawbacks aside, buying from a family member can put you at a significant advantage. If you’re looking for a home loan to purchase a property below its market value, a good mortgage broker can help you navigate the process.
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Richard Whitten is a money editor at Finder, and has been covering home loans, property and personal finance for 6+ years. He has written for Yahoo Finance, Money Magazine and Homely; and has appeared on various radio shows nationwide. He holds a Certificate IV in mortgage broking and finance (RG 206), a Tier 1 Generic Knowledge certification and a Tier 2 General Advice Deposit Products (RG 146) certification.
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Taking into consideration the above example, where you buy a property below market value and pay Stamp Duty on the Market Value not purchase price – what happens in the next transaction when it comes to CGT?
Example: Buy a property for $450k, with a market value of $550k. Pay Stamp Duty on the $550k. Rent the property for x amount of years, and then sell. Is the CGT calculated with a base of $450 or $550k?
I am currently in the process of doing a favourable purchase with my parents investment property and trying to understand the transactions.
We currently have their property valued at $550,000 and looking to do a 15% deposit to avoid LMI with St George Bank. Therefore, the favourable purchase price is $467,500.
My question is how much will my parents receive at the end of the transaction before CGT?
It’s hard to answer this question without knowing more details. If your parents fully own the property (no mortgage) and sell it to you for $550,000, and you have a 15% deposit, your mortgage would be $467,500. But the property would still sell for $550,000, which is what your parents would get before CGT.
With favourable purchase, you should also keep in mind that you will need to pay stamp duty on the purchase. And the government will require you to pay this on the full value of the property. This means if your parents sold at a discounted price, the stamp duty must be calculated on the property’s real value.
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Hi,
Taking into consideration the above example, where you buy a property below market value and pay Stamp Duty on the Market Value not purchase price – what happens in the next transaction when it comes to CGT?
Example: Buy a property for $450k, with a market value of $550k. Pay Stamp Duty on the $550k. Rent the property for x amount of years, and then sell. Is the CGT calculated with a base of $450 or $550k?
Hi M,
This guide from the ATO might explain it more clearly.
The CGT is also calculated based on the market value. But I’d recommend checking with an accountant as they can give you personalised guidance.
I hope this helps.
Richard
Hi,
I am currently in the process of doing a favourable purchase with my parents investment property and trying to understand the transactions.
We currently have their property valued at $550,000 and looking to do a 15% deposit to avoid LMI with St George Bank. Therefore, the favourable purchase price is $467,500.
My question is how much will my parents receive at the end of the transaction before CGT?
Hi Raymond,
It’s hard to answer this question without knowing more details. If your parents fully own the property (no mortgage) and sell it to you for $550,000, and you have a 15% deposit, your mortgage would be $467,500. But the property would still sell for $550,000, which is what your parents would get before CGT.
With favourable purchase, you should also keep in mind that you will need to pay stamp duty on the purchase. And the government will require you to pay this on the full value of the property. This means if your parents sold at a discounted price, the stamp duty must be calculated on the property’s real value.
I hope this helps.
Cheers,
Richard