When buying a new property that is yet to be constructed, buyers will be purchasing using either a ‘one-part’ or ‘two-part contract’. It is important to know which system is being used by the developer of your new off-the-plan property as it has a significant impact on the costs you will incur to purchase. The difference is all based on the concept of ‘progress payments’, which we will explore in detail.
TWO-PART CONTRACT
- Very common amongst house and land packages
- Buyers usually sign a contract with the land developer for the land component, and then a separate contract with the builder for the build component
- As such, buyers are required to settle on the land portion, and then pay ‘progress payments’ during construction
- Progress payments are essentially a ‘drip feed’ of payments made to the builder over the course of construction to fund the works (eg: materials and labour). At key milestones along the way, buyers will be required to make payments based on the pre-determined %s of the build contract price.
ONE-PART CONTRACT
- More common amongst apartment and townhouse purchases
- Buyers sign a single contract with the developer, covering both the land and building component
- A deposit is paid upon contract signing, and then the balance of the property price is paid at settlement
PROGRESS PAYMENT SYSTEM (two-part contract)
PROGRESS payment system: $400,000 purchase price (building value = $200,000)
- The buyer settles on the land component first after 3 months of contract signing, which would trigger interest payments to commence on their partial loan (initial loaned amount at this stage = $200,000).
- As the construction progresses, at various stages the builder will ask for progress payments to cover the cost of labour and materials used to date. These payments would happen at key milestones of the build (eg: slab, frame, lock-up), and require the buyer to ‘draw-down’ (request partial funds) from their lender.
- These payments continue and the mortgage loan amount gradually increases during construction.
- Eventually the final construction progress payment is made at settlement and keys are handed over, which at this time the mortgage has reached its full limit.
Interest paid summary:
- Land/build deposit until land settling: $450 (3 months)
- Land settling until construction commencing: $3,150 (3 months)
- Construction commencing until settlement: $9,100 (6 months)
- Total interest repayments before settlement = $12,700
The problem is that the buyer receives no tangible benefit from these partial-mortgage interest repayments. The building cannot be lived in or rented out yet, which means there is significant opportunity cost on the repayment funds. That is, the repayments are cash that could have been used elsewhere for the time being.
vs NO PROGRESS PAYMENT SYSTEM (one-part contract)
NO PROGRESS payments system: $400,000 purchase price (one-part contract)
- The buyer needs to place a single 10% deposit on the one-part, no progress payment contract (ie: $40,000, funded either by cash deposit or potentially funded by a re-draw from existing equity).
- The land and building contract is all wrapped into one, with the developer to fund all construction costs along the way.
- The buyer does not need to commence drawing down their mortgage, so there is no need to start paying interest repayments.
- Once the building is complete, the keys are handed over and the contract is settled. Only then will the buyer’s full mortgage commence charging interest, but fortunately at this stage the property can be rented out (generating income to offset the interest repayments) OR be lived in by the owner-occupier (and thus no need to pay rent anymore).
Interest summary (in the case of the deposit funds being loaned):
- 10% contract deposit until settlement: $2,400
- Total interest repayments before settlement = $2,400
Note: If the deposit was funded by personal case, as is the case in most first home or owner occupier purchases, the interest paid before settlement is $0.