Paying out the seller's mortgage at settlement: how the funds line up

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Kooky

Builder of Shaka, the payment router that pays every agent their commission on closing date.

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A seller with a home loan does not repay the bank and then sell the house. The sale repays the bank. On settlement day the buyer's money comes in, part of it goes straight to the seller's lender, the lender lets go of the property, and what is left reaches the seller. All of this happens in a few minutes and none of it in sequence, because no party is willing to go first.

How a seller asks the lender for a release, and how long lenders take to prepare one, is a subject for the weeks before settlement. This guide is about the day itself and the money. It sets out where the funds come from, where they go, how the lender's payout figure fits into the total, how the two sides of the ledger are made to balance, what the banking system does at the moment of exchange, and what happens to the arithmetic when the price falls short of the debt or the date moves. It uses one illustrative sale throughout. It describes the general mechanics and is not advice on any particular loan or contract.

The standoff that settlement resolves

Three parties want something and each has a reason not to give first.

The seller's lender holds a registered mortgage over the property. It will sign a release, the registry's Form 3, only if it is certain of being paid what it is owed. The buyer, and the buyer's lender behind them, will part with the price only if they are certain of receiving a title with that mortgage removed. The seller needs both things to happen, and cannot produce either alone: the money is the buyer's and the release is the bank's.

The old answer was a meeting at which cheques and documents crossed a table at the same moment. The present answer is an electronic workspace in which every payment and every document is prepared in advance and then executed together. Titles Queensland's guidance says the transfer, the mortgage and the release of mortgage are all among the instruments that, since 20 February 2023, must be lodged through an electronic lodgment network when professionals are acting. The seller's loan is therefore paid out inside the same system that changes the owner on the title.

Where the money comes from

The workspace holds a financial settlement schedule. PEXA, the larger of the two network operators approved in Queensland, describes it on its public pages as the record of all the funds in the transaction, which the participants must review and approve before settlement can proceed. The schedule has two sides.

The first side lists sources: where money will be drawn from. In an ordinary purchase there are two.

The buyer's lender is the larger. It advances the loan, drawing on its own account in the banking system. The amount is the loan less anything the lender deducts under the loan contract.

The buyer's own contribution is the other. It is the part of the price covered neither by the deposit nor by the loan, and it usually sits in the trust account of the buyer's solicitor or conveyancer, paid in by the buyer some days earlier so that it has cleared. The operator's description refers to practitioners nominating approved source accounts for this purpose.

One sum is conspicuously absent. The deposit is not a source of funds on settlement day, because it has been sitting with the deposit holder, usually the seller's agent, since shortly after the contract was signed. The settlement figures give the buyer credit for it, and the deposit holder deals with it separately afterwards.

Where the money goes

The second side lists destinations: who is to be paid. There are normally three or four.

The seller's lender comes first in every practical sense. It is paid the amount it has stated as the price of releasing its mortgage, the payout figure.

Other creditors of the property come next if there are any. Overdue council rates, an unpaid body corporate levy or a second mortgage are paid from the proceeds so that the buyer receives the property clear of them.

The seller's solicitor or conveyancer may take a line for professional fees and outlays, paid into the firm's trust account, if the seller has agreed to that.

The seller takes the remainder, paid to a bank account the seller has nominated in writing, or onward into another settlement if the seller is buying on the same day.

The schedule must balance to the cent. The total of the sources has to equal the total of the destinations, and both have to equal the amount the contract requires the buyer to pay at settlement once the deposit and the adjustments are taken into account.

One sale, traced dollar by dollar

A worked example makes the structure visible. The figures are invented for illustration. Assume a house sold for $850,000, with a deposit of $42,500 already held in the agent's trust account, and a single adjustment of $600 in the seller's favour for council rates paid beyond the settlement date. The buyer has a loan of $680,000. The seller owes a lender $412,300 on the settlement date and has agreed to pay $2,400 in legal costs from the proceeds.

The amount due at settlement is the price, less the deposit, plus the adjustment: $850,000 less $42,500 is $807,500, and adding $600 gives $808,100.

The seller's lender receives a little over half of what moves. The seller sees $393,400 from the settlement. The deposit follows separately: if the agent's commission and marketing costs under the appointment came to $24,000, the agent would keep that from the $42,500 and send the seller the remaining $18,500. The seller's total from the sale would then be $411,900. The same figure can be reached the other way, as a check: the price of $850,000, plus the $600 adjustment, less the loan payout of $412,300, the legal costs of $2,400 and the agent's $24,000.

The buyer's side reconciles too. The buyer has paid $42,500 as a deposit and $128,100 at settlement, $170,600 in all, and has borrowed $680,000. Together that is $850,600: the price plus the adjustment.

The payout figure is tied to a date

Of all the lines in the schedule, the lender's is the one the seller controls least and the one most likely to change.

A payout figure is not the balance shown in a banking app. It is the amount the lender requires on a named day to close the loan and give up its security. It includes the principal outstanding, the interest that has accrued since the last time interest was charged to the account, and whatever fees the loan contract allows the lender to charge for a discharge. Because interest accrues daily, the figure is correct for one date only.

The lender calculates it and enters it into the workspace itself. The seller's solicitor does not key in the bank's number, and the seller does not have to pass it on. This is one of the quieter advantages of the shared workspace: the party that knows the figure is the party that types it.

The seller's own behaviour can move it as well. A redraw taken from the loan in the last days before settlement, or a scheduled repayment that does or does not go through, changes the balance the lender is counting on. Lenders commonly restrict a loan account shortly before settlement for this reason.

Making both sides balance

In the days before settlement each participant completes its part of the schedule and the workspace shows whether the two sides agree.

They often do not at first. The buyer's solicitor has calculated the amount due under the contract. The seller's solicitor has done the same and may have reached a slightly different number because a rates figure was read differently. The lenders have added their lines. The workspace displays the discrepancy, the practitioners resolve it, and the affected lines are amended.

When the totals match, each participant approves the schedule and signs. The operator's description is that participants must review and approve the schedule before proceeding. Any later change by one participant, such as a lender updating its payout figure, removes the approvals that depend on it, and they have to be given again. Settlement cannot run on a schedule that someone has not approved in its final form.

Authority sits behind each approval. Guidance from the Australian Registrars' National Electronic Conveyancing Council on the client authorisation form says it allows a representative to authorise any financial settlement involved in the transaction. The Queensland Law Society's trust account alert on the networks adds that where trust money is used, that form must be completed, because section 249 of the Legal Profession Act 2007 allows trust money to be paid out only at the direction of the person it is held for. The seller's written nomination of a bank account for the proceeds is part of the same chain of authority.

The instant of exchange

At the booked time, if every document is signed and the schedule is approved, the system runs. What it does with the money was set out by the Reserve Bank of Australia in a Bulletin article of March 2021.

The banks do not send one another the gross amounts line by line. The Bulletin explains that each institution's roles in a transaction are netted to a single position. In the worked example, if the buyer's lender and the seller's lender were different banks, the first would have a paying position and the second a receiving one. If they were the same bank, most of the money would never leave it. The Bulletin records that in 2020 about 6 per cent of PEXA settlements involved only one financial institution and so produced a batch with a value of zero, which was sent to the Reserve Bank's system anyway for consistency.

During the reservation, the money belongs to nobody in the sale. The Bulletin says the seller has no rights to the funds while they are reserved and that they can be used only to settle that property transaction. For the seller's lender this is the assurance it needs. Its release is lodged only when the money to repay it is locked in place, and the money is released to it only when the registry has acknowledged the lodgement. The Bulletin describes the arrangement as approaching delivery versus payment and as removing the risk that one side performs and the other does not.

The article gives a sense of scale for 2020: an average reservation of six and a half minutes, and a median batch value of around $640,000.

When the price does not cover the debt

The schedule has no way of balancing if the destinations exceed the sources. Where the seller owes more than the sale will produce, something has to be added to one side or taken from the other.

Suppose the payout figure in the example were $830,000 and not $412,300. The destinations would total $832,400 with the legal costs, against sources of $808,100, a gap of $24,300 before the seller received anything. The deposit would cover some of that only after the agent had been paid from it.

There are two ways to close such a gap, and both need the lender's agreement well before the day. The seller can add money: a further source line, drawn from the seller's solicitor's trust account, funded by the seller from savings. Or the lender can agree to accept less than the full payout as the price of releasing this property, with the remaining debt dealt with under a separate arrangement. In the second case the lender enters the lower figure in the workspace.

What cannot happen is a settlement that leaves the mortgage on the title. The buyer's lender will not advance against a property that still carries someone else's security. A shortfall that is discovered late is, for this reason, one of the common causes of a settlement that cannot proceed on its date.

More than one loan, and a purchase on the same day

Real sales add lines to the schedule without changing its logic.

A home that secures several loans with one lender has one payout line covering all of them, because the lender's security covers all of them. A home with a second mortgage to another lender has a second payout line and a second release, and each lender enters its own figure.

A seller who is buying another home the same day can direct the balance of the first settlement into the second. The destination line in the sale becomes, in effect, a source line in the purchase. The two settlements then depend on each other: if the sale is delayed, the money for the purchase is not there. Practitioners manage this by booking the sale first and leaving time between the two.

A seller keeping the same loan and moving it to a new property is a different case. The lender still releases the first property, but the payout line may be small or nil, and the lender takes a new mortgage in the purchase.

After the money has moved

For the lender, settlement ends the matter quickly. It has been paid, it closes the loan account, and any credit facility attached to the loan ends with it.

For the seller, the balance arrives through the banking system. The interbank payment is made at once, according to the Reserve Bank's description, and the receiving bank then credits the seller's account. How soon the amount is visible and available depends on that bank.

On the register, the mortgage is gone only when the release is registered, not when it is lodged. Brisbane City Council's guidance on changes of ownership, citing the registry, gives three to five working days for registration where all requirements are met. A title search after that shows the buyer as owner, the buyer's lender as mortgagee, and no trace of the seller's loan.

The deposit follows its own path. The Office of Fair Trading's guidance says an agent may pay a deposit out of trust only once the sale is finalised, must pay the seller first or at the same time as other payments, and takes commission last. The Queensland Government's guidance for sellers adds that the agent must give a written statement of account within 42 days, or within 14 days if asked.

What can still change the figures

Because every line depends on the settlement date and on facts that are confirmed late, the schedule is rarely final until the day before.

In every row the balance to the seller absorbs the change. It is the last line calculated and the only one with no fixed claim behind it, which is why a seller's final figure is confirmed so close to the day and why the estimate given a fortnight earlier is only an estimate.

The seller's lender is paid first and trusts nobody, and the system is built so that it does not have to: its release and its money are locked together until both can move.

Kooky, from Shaka

Kooky edits Queensland Estate and builds Shaka, the payment router he made for Queensland property professionals. One payment comes in, and every agent, agency and party in the deal receives their signed share on closing date.

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