Exit strategy: refinance or sale to repay

Why the exit comes first

Private property loans are usually designed to last months rather than decades. The lender is not expecting you to repay slowly from income over a long period. It is expecting a single event, such as a refinance or a sale, to repay the whole loan at maturity. That makes the exit the most important part of the lender's assessment. A strong property with a weak exit can still be a poor loan; a modest property with a clear, well-evidenced exit can be a good one.

Our lesson on exit strategies and backup exits introduces the idea. This article compares the two most common exits and how lenders test them.

Exit one: refinance

A refinance exit means a new lender, often a bank, repays the private loan. This is common when the private loan was needed because the borrower or property did not yet meet bank criteria, for example:

• a construction project that will meet bank criteria once complete and leased;
• a borrower whose recent financial statements will soon show improved income;
• a bridging loan where the borrower will sell another property;
• a property that needs repairs or a change of use before a bank will lend.

How lenders test a refinance exit

Lenders look at whether the borrower is likely to meet the refinancing lender's criteria at maturity. They consider:

• Valuation. What will the property be worth when the refinance is needed?
• Leverage. Will the loan amount, including capitalised interest and fees, fit within the refinancing lender's maximum loan-to-value ratio?
• Serviceability. Will income, rent or business earnings meet the new lender's interest cover or debt service tests?
• Credit history. Are there defaults or arrears that would worry a bank?
• Time. Is the term long enough to complete the steps needed?

Our lesson on LVR, ICR, DSCR and other ratios explains the measures. Bank criteria are shaped by prudential settings, covered in our guide to APRA rules and bank lending limits.

Exit two: sale of property or completed stock

A sale exit means the loan is repaid from selling the security property or, for developers, from settling completed units or lots. It is common for development loans, land loans and residual stock loans.

How lenders test a sale exit

Lenders look at whether the sale will happen in time and produce enough money. They consider:

• Pricing. Are the expected prices supported by recent comparable sales and a valuation?
• Pre-sales. For developments, how many units are already under contract and how strong are those buyers?
• Absorption. How quickly can the remaining stock realistically be sold in the local market?
• Costs of sale. Agent fees, marketing, legal costs, GST and any withholding reduce the net proceeds.
• Settlement risk. Buyers may fail to settle, especially if values fall or finance is harder to obtain.

GST and purchaser withholding can materially reduce the cash available at settlement. See our guide to the GST margin scheme and development cashflow. For foreign sellers, capital gains withholding may also apply; see FIRB rules for foreign borrowers.

Comparing the two

Certainty. A sale exit can be more certain if contracts exist, but buyers can still fail to settle. A refinance exit depends on criteria that can change over the term.

Timing. Sales depend on market conditions and settlement dates. Refinances depend on credit processes and valuations.

Cost. Sale costs and GST reduce proceeds. Refinance costs include new establishment fees, valuations and legal costs.

Control. A refinance keeps the property. A sale gives up the asset but clears the debt.

Many borrowers plan a combination, such as selling some stock and refinancing the remainder with a residual stock loan.

Building a backup exit

Lenders often ask, "What if your main exit does not happen on time?" A credible backup might be:

• selling another property;
• refinancing with a different lender type;
• converting unsold units to a residual stock loan;
• injecting more equity from other sources;
• negotiating an extension in advance.

Ask the lender at the start what extension terms are available and what they cost. Our guide to term sheet fees and default clauses explains extension fees and default interest.

Watch the maturity date

Missing the maturity date is one of the most common ways borrowers end up in default. Diarise key dates, start refinance applications or sales campaigns well ahead of maturity and keep the lender informed. If you foresee a delay, talk to the lender early rather than waiting until the loan has expired.

If things go wrong, our guide to AFCA complaints for borrowers explains where complaints can go, and our lesson on default and enforcement explains what happens if a loan is not repaid.

A short exit checklist

• Write down the main exit and the evidence for it.
• Identify a realistic backup exit.
• Check leverage at maturity, including capitalised interest and fees.
• Include sale costs, GST and withholding in net proceeds.
• Build a timeline with buffers for delays.
• Confirm extension terms before you sign.

A worked example

A developer, Taylor, completes a project of several townhouses funded by a private construction loan. Most townhouses were pre-sold, but a few remain unsold at completion. Taylor's main exit is settlement of the pre-sold units, and the backup is a residual stock loan over the remaining townhouses. When one buyer fails to settle because their own finance fell through, the settlement proceeds fall short of the construction debt. Because Taylor had already discussed a residual stock loan with another lender and obtained an updated valuation, the shortfall is refinanced within weeks, avoiding default interest on the construction loan. Taylor then sells the remaining stock over the following months and repays the residual loan.

What lenders want to see in your exit evidence

• A valuation or appraisal that supports the expected sale price or refinance amount.
• Copies of sales contracts and deposit details for pre-sold stock.
• A letter or indicative terms from a refinancing lender, where available.
• Financial statements showing the income a refinance will rely on.
• A timeline showing the steps between now and repayment, with buffers.

When the market changes

Property markets and lending conditions shift over the term of a loan. Values can fall, buyers can become harder to find and banks can tighten criteria. Review your exit regularly during the loan, not only at the start. If the outlook changes, adjust early, for example by reducing prices, starting a refinance sooner or arranging an extension before maturity. Lenders tend to respond better to borrowers who raise problems early with a revised plan than to borrowers who contact them after the maturity date has passed.

Talking to the refinancing lender early

If refinance is your exit, approach the likely refinancing lender well before maturity. Ask what it will need to see, such as completion certificates, leases, financial statements or a minimum level of sales, and when it will need it. Their answers become the checklist for the rest of your private loan term.

Further reading

• Bridging finance
• Development site exit scenario
• Australia's private credit market
• ASIC registers guide
• Caveat and second mortgage registration