Buying at a mortgagee sale: a bargain or a costly trap?

Rising costs, delayed deliveries of building materials and tighter lending putting downward pressure on prices have recently led to development projects being offered by banks through mortgagee sales. For example, a financier of Totara Vale Sunnynook Central, a development of 15 townhouses, initiated a mortgagee sale after developer Sunnynook Central LP was unable to repay its debt.

Properties offered through mortgagee sales are commonly called court-auction properties in the Chinese community. If one happens to catch your eye, should you buy it? How does buying through a mortgagee sale differ from an ordinary auction? Today we discuss some questions about mortgagee sales in New Zealand.

One: how does a mortgagee sale arise?  

In New Zealand, a mortgagee sale involves a creditor auctioning a debtor's mortgaged property. The mortgagee is the creditor that lends to the mortgage borrower, most commonly a bank, although it may also be a finance company or private lender. 

A borrower, or debtor, usually mortgages their property to the bank when taking out a loan. If the mortgage debtor cannot fulfil the contract or repay the debt, the creditor may, under the loan agreement's terms, use judicial procedures to force an auction of the property registered in the debtor's name and apply the proceeds towards the debt.

Two: my own home is mortgaged to the bank. Could it be auctioned?

New Zealand is a fair country governed by the rule of law, and a mortgagee sale does not happen overnight. Before applying for enforcement, a bank needs to consider the following factors:

1. Is the loan agreement a consumer credit contract?

The Consumer Credit Contracts and Consumer Finance Act 2003 (CCCFA) clearly defines which loan agreements are consumer credit contracts. Relevant considerations include, but are not limited to, whether the borrower is an individual and whether the loan is for personal or household purposes.

If a loan agreement is a consumer credit contract, the bank must meet stricter responsible lending requirements, with additional compliance obligations during a mortgagee sale. However, loans for commercial or business purposes, such as borrowing in a company's name, fall outside the CCCFA's consumer credit contract provisions. 

 

Have the conditions for starting a mortgagee sale been met? What does the process involve?

1. The first step is, naturally, a breach of contract. The most common breaches include overdue repayments or interest not paid on time. Other breaches include demolishing a house without the bank's consent, providing false information or violating relevant loan conditions.  
2. Generally, once a breach has occurred, the bank first sends the borrower an appropriate notice. If repayments are overdue or money is owing, it issues a demand notice, usually specifying the amounts payable and overdue. 
3. If payment is still not received after the demand notice, the bank's next step is to issue a Property Law Act (PLA) notice. Under section 120(1)(c) of the Property Law Act 2007, the creditor must notify the debtor that the breach must be remedied and specify the deadline for doing so. This period currently cannot be shorter than 20 working days. Only then may the creditor exercise its mortgage rights to take possession of or sell the mortgaged property. 

Only if the PLA notice expires without the debtor remedying the breach does the creditor have the right to:

1. Enter or take control of the land;
2. Manage the mortgaged land and collect all income associated with it, such as rent;
3. Auction or sell the mortgaged land through a mortgagee sale.  

It is worth noting that the creditor does not become the property's owner during this process, but is simply the party entitled to enforce its rights. 

1. The property can then enter the auction process for a forced sale to repay overdue debt, interest and related enforcement costs. 
2. If the auction proceeds do not cover all the debt, the creditor retains the right to pursue the outstanding balance.

Section 176 of the Property Law Act 2007 expressly requires creditors to act for a proper purpose and take reasonable steps to obtain the best sale price. It is therefore advisable to engage an experienced valuer or real estate agent to advertise the property and ensure adequate market exposure. A specific mortgagee sale agreement is also used for the auction.

 

Three: how does buying through a mortgagee sale differ from buying another property?

As explained above, properties offered through mortgagee sales are what the Chinese community calls court-auction properties. Many people hesitate to buy them, or believe they should not be bought, mainly because of the potential risks. The most important point is that, unlike an ordinary property sale and purchase agreement, a mortgagee sale agreement contains numerous disclaimers. This is because the bank is enforcing the sale, has no control over the property itself and cannot provide the usual vendor warranties.

Common disclaimers in mortgagee sale agreements fall into the following categories:

1. The agreement excludes basic vendor warranties, including any guarantee of government approvals for the property. For example, there is no guarantee that the house has building consent or that no unauthorised additions or alterations were made during the owner's tenure. Removing these warranties increases the risks associated with the property at auction.
2. Vacant possession on settlement is not guaranteed. Mortgagee sales are generally forced sales, and owners may not cooperate with the process, including refusing access to prospective buyers or refusing to move out. Removing the former owner can therefore become a major problem for the new owner. The new owner is entitled to remove the previous occupants only after settlement, and enforcement requires relevant court applications and takes time.
3. Items in the house may be damaged or removed. The bank will specifically state at auction that it gives no warranties for any assets in the house. In extreme cases, owners may deliberately damage furniture and walls or take everything they can remove.
4. Risk and liability arrangements differ from those in other auctions. In a mortgagee sale, all liability and risk associated with the property pass to the new owner when the hammer falls. In other words, if the house is uninsured and burns down during this period, the buyer must still complete the transaction under the agreement, even though settlement has not yet occurred.

 

Four: essential legal due diligence

Because pitfalls can be difficult to guard against, we recommend engaging professionals before the auction to investigate the property and its title, giving you a comprehensive understanding of every aspect of the house:

First, I strongly recommend obtaining an unsigned sale and purchase agreement before buying through a mortgagee sale, then asking your lawyer to explain the process and clarify its risks. Your lawyer should also explain the special conditions in detail and confirm whether the price includes GST, so you avoid paying the vendor an additional 15% in GST.

Second, examine all records and documents to gain a thorough understanding of the property. Obtain a building report, a drug contamination report and a LIM report to assess its condition in detail, and decide only once you are satisfied. If you do buy, settle as soon as possible to reduce the risk of damage to the property.

Third, discuss loan approval with your bank in advance. Some banks are concerned that damage could reduce the value of their security and usually require written confirmation from a lawyer that the buyer understands the risks in the mortgagee sale agreement. Allow enough time before the auction to complete these steps and meet the bank's requirements.

Fourth, arrange insurance before attending the auction, ensuring that cover is in the buyer's name from the moment the bid succeeds.

 

Every property has an appropriate price, and finding a bargain is certainly possible. Before buying, purchasers should understand the property's overall condition and factor every disadvantage into their final price. Whether you are new to the property market or experienced, we recommend engaging a qualified lawyer before participating in a mortgagee sale. Have your lawyer review every clause carefully and explain each risk in writing, ensuring you understand every expense and ultimately buy the home that suits you best.