What does settlement of a loan mean?

Home loan settlement often refers to the process of finalising a mortgage and accessing the funds provided by a bank or lender.

It typically takes place during the refinancing process (in refinancing transactions) or at the same time as property settlement (in purchasing transactions).

Home loan settlement typically allows one party –  the new lender – to provide funds to another – either the old lender or the seller. 

A sound home loan settlement is key to a smooth property transaction.

What is home loan settlement: Refinancing

The term ‘home loan settlement’ is commonly used during the refinancing process, when a borrower is changing lenders or mortgage products (or both), generally in order to access a better deal.

As part of the home loan settlement process, funds will generally be made available through the new debt facility. 

Those funds will then be used to pay down the balance of a borrower’s old debt facility. 

If you're refinancing, don’t expect to receive the value of your mortgage in cash, however. Your new lender will normally hand the money it's loaned to you straight to your previous lender. 

After that, you can officially relax in the knowledge you’ve got a better home loan offering.

See also: Ultimate guide to refinancing your home loan

Home loan settlement also involves various legal and administrative tasks, such as discharging your old home loan and registering the new mortgage against the property. Your new lender will normally take responsibility for such paperwork. 

Though, your old lender might ask that you fill out a discharge authority form in order to close your old facility, while your new lender might ask for documentation to discern if your property is adequately insured. 

After a home loan settlement, the new lender should make the borrower aware of when their first repayment will be due on their new facility, and their repayment schedule going forward.

It’s also important to note that there’s another use of the word ‘settlement’ that might confuse some borrowers. While the term can colloquially refer to paying off a debt or an account – like settling a tab at a bar – in real estate contexts, its meaning differs from this everyday usage. 

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Home loan settlement when buying a new home

In instances in which a home is changing hands, the settlement process is typically called property settlement. 

Property settlement includes many of the same steps as the home loan settlement process that takes place during refinancing. 

That’s particularly the case if the seller has an active home loan on the property and the buyer is taking out a mortgage in order to afford their purchase. In such cases, the seller’s home loan will typically also need to be discharged and the buyer’s home loan registered against the property.

Property settlement also involves numerous additional steps, including the transfer of ownership and the payment of stamp duty. 

The property settlement process is generally managed by a conveyancer or solicitor, who will ensure all necessary checks are done and the transfer of land and mortgage is properly registered.

At the point of property settlement, the buyer becomes responsible for the mortgage debt and, in exchange, should receive the keys to their new property.

They should also be made aware of when their first home loan repayment is due and how often they need to make repayments in the future.

See also: Settlement day checklist 

Property and home loan settlements might be made more complicated if a bridging loan is relied upon.

A bridging loan is a type of mortgage product typically provided to a person who is selling one property in order to buy another. 

In such cases, a bridging loan can be used to pay for the property being purchased on the proviso it will be repaid with the funds garnered from the sale of the property being sold.

What is a settlement statement? 

A settlement statement is a document detailing all the financial aspects of your property transaction. 

It will include costs such as stamp duty, government titles, and First Home Owner Grants, if applicable. It might also include some information regarding the value and interest rate of a mortgage taken out to purchase a property.

In saying that, a settlement statement isn’t exclusively related to your home loan. You will likely receive separate documentation from your lender around the time of settlement detailing your loan and repayment amounts. 

Are there any risks involved in settlement?

There is always the risk that one party may fail to deliver the terms of a contract with another party at the time of property settlement. This could delay settlement or even void the contract of sale.

For instance, the buyer’s bank might drag its heels in providing the funds needed to execute the sale, or a buyer mightn’t ultimately be approved for a home loan. 

If a buyer can’t get the final tick of approval from a lender to finance their home purchase, they might default on their sale agreement and forfeit any funds they’ve put towards it.

Settlement risks are significantly lowered in the case of refinancing, as exclusive home loan settlement is a far less complicated process. 

Settlement risks when buying off the plan properties

Settlement risk is often considered greater for off-the-plan property purchases, as the time between the signing of the contract and the completion of the project can see a borrower in a notably different financial position.

There is a world in which a bank agrees to lend a buyer a certain amount to purchase an off-the-plan property, but when tools are put down, the newly built property is worth less than the borrowed amount. 

That could mean a borrower is left with a higher loan-to-value ratio (LVR) than expected and might be forced to either top up their deposit or take out lenders mortgage insurance (LMI). In one worse case scenario, a bank might refuse to lend the money for the purchase due to the new valuation, thereby potentially forcing the buyer to forfeit the sale.

Failure to settle on an off-the-plan purchase may have consequences, including loss of deposit.

How can you avoid settlement risk?

Avoid overstretching your finances

The price tag on a property is far from the only expense facing a homebuyer. Other costs, such as stamp duty, conveyancing fees, and mortgage registration fees, can add up to tens of thousands of dollars.

Thus, it's probably worth giving yourself some financial breathing space in case you need to tap into additional funds during the settlement process. 

Prepare for the worst-case scenario

Off-the-plan buyers often hope that by the time their property has been built its value will be higher than the price they purchased it for. 

To avoid settlement risk, a buyer might choose to arrange their finances so as to cater for a worst-case scenario: The property’s value falling below the contract price. 

Enlist the help of professionals

If you’re unsure about the settlement process or you’re anxious about settlement risks, you might want to reconsider DIYing your property purchase.

Buyers and sellers alike have been known to do their own conveyancing, and many homebuyers hunt down their own home loan deals. 

While DIYing aspects of a property purchase could certainly see a buyer better off, it’s not guaranteed to be the case. 

Sometimes it's worth going to the professionals, even if it’s simply to save peace of mind.

Conveyancers, financial advisors, and mortgage brokers are there to help buyers in their property purchasing process. 

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