THE FINANCING CONTINGENCY OF A CONTRACT CAN BE PLAYED LIKE A STRADIVARIUS!
The FINANCING CONTINGENCY can make or break a Contract of Sale. Read it carefully.
You may just have to eat that mortgage rate!? Make it a tasty one. by Alan May is loaded with great information for agents. Alan writes about the fnancing contingency with a focus and good tip about owner financing.
THE FINANCING CONTINGENCY DOES NOT ALWAYS PROTECT THE BUYER. I have found by reviewing hundreds of contract prepared by agents that the financing contingency is one of the most neglected and least understood paragraphs in the Contract of Sale.
Many agents believe that the financing contingency gives the buyer an easy way out of a Contract of Sale simply because the buyer fails to get loan approval. That's not always accurate. The financing contingency cannot be exercised if:
- The buyer has misrepresented their financial ability to obtain a mortgage.
- The buyer has misrepresented their funds to close.
- Through actions of the buyer, financing a new vehicle, etc., the credit picture has change and the buyer is no longer qualified.
- The buyer has not cooperated with the loan process.
In all of the above causes of loan denial, the seller has a claim on the Earnest Money Deposit.
WHAT INTEREST RATE TO PUT IN THE FINANCING CONTINGENCY? Suppose the buyer has a pre-approval letter than states that the buyer is qualified for a $300,000 loan at 5%. Would you enter 5% in the financing paragraph?
YES, if you're the buyer's agent. Further, you'd cross your fingers and hope the seller accepts the financing contingency with an interest rate of 5%. Sadly, if the buyer's qualification is marginal and interest rates increase while the loan is in processing and the rate was not locked, they are not likely to get through underwriting. I pays for buyer's agents to understand the buyer's financial profile and avoid writing on homes in price ranges up to the limit of the buyer's highest qualifying range. If rates are falling, the risk in minimal. However, if rates are rising or volatile, the contract is at risk.
However, if you're a listing agent, you'd advise your seller to counter the 5% to a higher rate, perhaps 5.5% or 6%. Advising a seller to accept a contract with 5% would mean that, if rates went up,the buyer may not be able to close. If the buyer is only qualified for $300,000 @ 5% and rates go up, the buyer wouldn't be qualified and could exercise the financing contingency.
THE FINANCING CONTINGENCY CAN ALSO PROTECT THE SELLER. It only makes sense that, if a seller receives and offer with a price of $300,000 accompanied by a pre-approval letter that has a 5% rate, the listing agent might recommend that the seller counter the interest rate in the contract to 5.5% or 6% or even 6.5% if settlement is more than 45-60 days future. This is a safe practice for Short Sales. A careful analysis of the buyer's financial statement is recommended if they are customary in your market. At the very least, a discussion with the buyer's loan officer to determine if the buyer can qualify at a higher rate protects the seller.
WRITING OR ACCEPTING A CONTRACT for a buyer that is marginally qualified puts the buyer and seller at risk. When agents understand the intricacies of the financing contingency, neither the buyer, seller nor agents will be faced with a loan denial.
As mortgage financing becomes more difficult, it's important for Buyer's Agents and Listing Agents to pay close attention to the financing contingency and make sure that the buyer is well qualified.
"The offer is good but the buyer's lender's letter is written to today's interest rate. If interest rates go up, the buyer could exercise the financing contingency. I recommend that we counter the interest rate in the contract to 1% higher."
Well done Lenn...as always...
Hi Lenn...I like your article...It points to something that many have avoided talking lately. Here in Denver, I would say the contingency is something that may not have been taken very seriously a few years ago. I don't think that is true anymore. Everyone seems to be paying attention to every little detail as we should. It is there for a reason and if used properly, it can serve both buyer and seller. But like anything else, it can also be abused.
Lenn,
Fantastic point, the rates are going to get a lot crazier this year. Great way to protect both buyers and sellers understanding the appraisal contingency!
All the best, Michelle
Lenn - Great points about an often misunderstood contract stipulation. An experienced and knowledgeable agent can help both buyers and sellers use the wording to protect their interests.
Lenn - Thanks for the post. As a new agent this valuable info for me.
Lenn - Thanks for the post. As a new agent this valuable info for me.
Lenn - Thanks for the post. As a new agent this valuable info for me.
Lenn- Such a great post! Working largely as a buyer's agent, I always put in the interest rate that the lender has preapproved the buyer at, or lower, if rates have dropped a bit. You point out a very important item, that is that the listing agents really need to look closely at the financing contingency to be sure the rate isn't so tight that it won't allow for even a minor rate climb. Thanks for sharing:)
Interesting. I wonder if we should now get pre-approval letters from lenders stating what the maximum the buyer can afford is so that we can see how much leeway they have with the interest rate. Getting these pre-approvals at exactly the amount of the loan, really doesn't mean too much these days.
From the desk of David Dee,
Lenn, this is a very nice summary of the financing contingency. This is something which both buyer and seller agent need to be cognizant of. Many overlooked this piece of the contract as I have witnessed some of the examples you've pointed out.
Hi Lenn,
Great article as always. I'm always very careful to adjust the contingencies to protect my clients. Aside from price, this is routinly one of the most important parts of the sales contract.
Lenn - great points as usual. But how do you prove that a buyer has misrepresented their ability?
Great post Lenn, and this one needs to be read by a lot of agents and customers.
I love the title Lenn and you are spot on about the financing contingency being one of the least understood parts of the contract. Over the years I have seen a numer of cases where buyers assume this is an automatic escape clause for them ~ WRONG!!!
Gabe. Thanks. Would that they would.
Penny. You don't have to prove it. The acceptance of a contract or mortgage application is based on what the prospective home buyer states when they complete the mortgage application or complete the Financial Statement to show their financing worthiness when they make an offer.
If the buyer states that they have $35,000 in liquid assets to close and their bank statements do not support that statement when they make loan application, they have misstated their assets and the seller, if they took their home off market has been damaged and has a claim on the earnest money deposit.
If the buyer, when making mortgage application or a contract offer states that they have no judgments or liens and their credit report reveals a $10,000 tax lien, the buyer has misstated their debt and the seller may have been damaged.
The important thing is for buyers agents, listing agents and lenders to be given truthful financial information.
Our financial statement is signed and dated by the buyer and if they misstated their ability to close, they can't rely on the financing contingency when the facts are revealed later on.
Bill G. HA! Not if the listing agent knows their business. Buyer's agents need to understand the risks to buyers earnest money if they recommend that their buyers misstate their financials to get a contract.
Andrew. In some cases, the financial strength of the buyer is more important than the price. I've had many buyers get contracts when there were several higher offers because the seller could see a well qualified buyer.
David. Thanks. Over the years, I am so surprised that so many agents don't explain this paragraph to their buyers and sellers.
Jane. I don't really care what the lender's letter says beyond the fact that the buyer has an acceptable credit score. I prefer to analyze the buyer's financial statement and look for a sound financial profile.
Jan. Glad to help. This paragraph is so important.
Tom B. Read the financing paragraph 10 times and it will become a valuable tool.
John M. Indeed. Agents who understand this paragraph won't have contracts fall apart at the last minute.
Michelle. Thanks. This year may be quite a challenge if rates begin to creep up.
John. Right. However, smart knowledgeable agents can protect their buyer or seller clients.
Toni. Thanks.
Lenn ~ Powerful information! When representing a seller and I receive and offer and feel that the buyers financial ability is shaky, I write in the contract that all parities agree that the property will remain in active status is the MLS until all contingencies are removed. This seems to keep the buyers agent and buyer on there toes while allowing the seller to obtain back up offers. I always do this for a home sale contingency. It seems once the status in MLS is changed - no more lookers.
Monique. Once the property is no longer ACTIVE, buyers don't see them in most IDX web sites and agents don't show although I have shown and sold Cont/KO. With a non-contengent buyer, that's a risk worth taking.
If a seller gets an offer from a shaky buyer, I'd simply leave it on the market until the buyer gets a loan commitment. If they don't agree to that, too bad. Back up contracts don't help serious home buyers nor their agents.
Lenn, after reading this, I pulled up Zip Forms and did my annual careful read of this important contingency. I think it's important that all of us know this one inside and out - along with the appraisal language.
Patricia. Agree 100%. An agent for a buyer or seller needs to not only paraphrase the paragraph for their client, they need to understand it and use it to their client's best interest.
a well written and thorough explanation of the issues. nicely done.
Hi Lenn -- Wow, serious stuff here. In our local PAs, we don't have interest rates and the language is fairly benign.
A very interesting post.. We do not focus on this clause and you have given a great explanation.
So many agents don't bother to properly fill out the forms and leave blank spaces. Buyers agents in the metro DC area using the "Regional Contract" should pay attention to the "or market rate available" as it might cost a buyer much more than they were anticipating. It is about the buyer qualifying, not what the buyer want to pay for interest.
This is an excellent summary. I had a couple of experiences with buyers who tried to play games with this one. That was early on- I know better now.
Excellent post Lenn. In Colorado we have mitigated some of these points by re writing our state approved forms to adjust the loan contingency to a loan conditions contingency. We no longer enter the interest rate as part of the contract! Its the buyers subjective discretion whether the conditions of the loan they are approved for are satisfactory to move forward!
Bob. In that case, if I were a seller, I'd want a high earnest money deposit, possibly some non-refundable if the buyer walked when fully able to get financing. I'd also want to see a detailed financial statement to verify the ability of the buyer to get financing.
If the seller takes their home off market and loses opportunity to show and sell, when a buyer just walks because they don't like the rates later one, the seller has been seriously damaged.
Ruthmarie. Good for you. Far too often agents tell the buyer that they can "always" get out on the financing contingency. Not so.
Yvette. Indeed. In fact, there should never, never, never be a blank in a contract. We had an investment buyer walk a week prior to settlement because she didn't like the rate she could get although we had been advising her to lok in for weeks. She wanted to forfeit the $5000 earnest money, but the seller wasn't satisfied, sued her for specific performance and got a judgment for another $25,000.
Joan. Good. Many new agents don't understand the meaning of some clauses in the contracts.
Chris. Mmmmm. A smart agents knows how to protect their client, buyer or seller.
Alan. Thanks. It's important and I love to write about the contract. They are complicated and take study.
Hi Lenn, Sorry I missed this one on the first go round. Understanding the financing contingency is critical to protect your buyer/seller interets. Excellent analysis !
Bill. Thanks. Inexperienced agents could benefit by reading the financing paragraphs again and again.
Agreed. It is one of the most important aspects of the Purchase Contract especially in this ever-changing financial climate. It is one of the first places my eyes go when receiving an offer.
Norma. YOu're a smart listing agent. A buyer cannot be held to a lender's letter. It pays to use the contract to make sure the seller is protected.
Looking at the interest rate in the offer makes a lot of sense, especially since many buyers are buying up to their limits and won't be able to qualify if rates go up.
This is particularly true if the client doesn't have cash reserves to buy down the rate.
Christine. Right you are. That is one of the main points of this post.
Lenn - I am reading all your financing contingency posts because i'm trying to make sure that I understand this throughly. I have read and re-read the paragraph it but it's nice to have your perspective. I do think the info about countering the interest rate is a good one because I'm not sure many people even consider that as a negotiating strategy.