Loan contingency protects buyers from mortgage SNAFUs

Don't count on lender's promises when submitting an offer

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Jul. 25, 2011

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Don't count on lender's promises when submitting an offer

Dian Hymer
Inman News™

Recently, a homebuying couple removed their loan contingency based on the verbal representation from their loan agent that the loan was formally approved -- most lenders won't issue written loan commitments. The buyers removed their contingency leaving them with a contingency-free contract.

The next step was for the lender to provide loan documents for the buyers to sign so that the funds needed to close the transaction could be issued. Many promises were made about when the documents would be ready to sign. The buyers were assured that the closing would occur on time.

A day after the contract closing date, the loan documents still weren't ready. It was only then that the lender informed the buyers that they did not have a loan. The buyers managed to stay in contract by requesting an extension of the closing. In consideration for this, they had to pay the sellers a nonrefundable deposit.

Unless you're paying all cash and the funds for closing are liquid and verifiable, your purchase contract should include a loan or financing contingency. With such a contingency, you are protected if you use due diligence to procure a loan, but are unable to obtain one. In this case, your deposit is usually returned to you when the contract is canceled. Purchase contracts might also include preapproval and appraisal contingencies.

HOUSE-HUNTING TIP: A preapproval letter from a lender is usually conditioned upon various items like receiving a copy of the purchase agreement, an acceptable appraisal and title report on the property, and often additional financial documentation from the buyers. In other words, it's not a formal loan approval.

Some buyers who find themselves in competition think it's a good strategy to waive the loan contingency, if they've been preapproved. This is risky in today's tough financing market. In 2005 and 2006 when qualification requirements were loose, a preapproval letter was usually as good as approval. Today that's not the case.

Don't make an offer without a loan contingency based on your loan agent or mortgage broker's representation that there will be no problem with your loan. You might lose out in a competitive bidding situation, but your deposit won't be at risk if you are unable to perform and aren't protected by a loan contingency.

Your purchase contract should dictate when the loan approval contingency is due. It is often specified as a number of days from acceptance. In today's market, it usually takes 21 or more days for a borrower's loan to be formally approved by underwriting.

Another option is to include a clause in the contract that says the loan contingency will be in effect until the loan is funded by the lender rather than a number of days from acceptance. Using this strategy, the buyer is protected if the lender delays or declines approval.

Sellers aren't fond of this way of handling the loan contingency because funding usually doesn't occur until the day of or before the closing, depending on where you're buying or selling. Buyers often want to take possession of the property at closing. However, many sellers won't move out of their homes until they know that the transaction has closed. This is understandable, particularly in the current market. You wouldn't want to be left with a vacant house and have to re-market it if the buyer's loan doesn't come through.

One way to deal with this situation is for the buyers to let the sellers stay in the property rent-free for several days after closing, so that they don't have to move out until they know the transaction has closed.

THE CLOSING: To be on the safe side add a couple of days to your loan contingency time period, even though your loan agent or broker thinks it's not necessary.

Dian Hymer, a real estate broker with more than 30 years' experience, is a nationally syndicated real estate columnist and author of "House Hunting: The Take-Along Workbook for Home Buyers" and "Starting Out, The Complete Home Buyer's Guide."

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