Financing Issues Get Even Trickier
As though today’s real estate financing market weren’t enough of a minefield, add to the mix. New regulations issued by FNMA, and soon to be enacted similar set by Freddie Mac, require lenders planning on selling loans in the secondary market to do a pre-closing credit check on borrowers before funding the loan. What does this mean for buyers? A lot.
Let’s recap how the process typically works and how most residential contracts allocate the risk of financing. In a “non-contingent” contract, the buyer is permitted to finance the transaction (e.g. get a loan) but the risk of obtaining that financing is on the buyer. Thus, a loan denial, or a refusal to fund, will not give the buyer an “out” under the deal and the buyer will be required to perform or face the risk of default. An uncured default in a residential contract in metropolitan NY and Long Island triggers permits the seller to retain the contract down payment, which is typically a hefty 10% of the purchase price.
That’s a big pill to swallow for most buyers. But in today’s market environment most deals are financing contingent, which means that most – but not all – of the risk of financing is moved to the seller’s side of the deal. So if a buyer promptly applies for a loan, and is denied, then the buyer can terminate within a certain time period from signing the contract, usually 30 or 45 days. But if the bank issues a loan commitment letter, and clears the appraisal condition, within the 30 or 45 day period, then the financing contingency language in the contract is typically of no further effect. So if the bank fails to fund the loan even after issuing the official looking loan commitment letter, the buyer is left without a remedy and will default if he can’t find another lender willing to make the loan.
And there is the risk. The “gap” between issuance of a loan commitment letter and the issuance of a check to pay for the apartment is usually a period of a few weeks during which time the lender usually completes the condition fulfillment to the loan commitment letter. Those conditions – the “fine print” of the loan commitment letter – include mundane and routine requirements, like copies of tax returns, pay stubs and verification of employment. But the new regulations add to these “fine print” conditions a second credit check after the loan commitment letter issues but before the lender funds. An unwitting credit move by the borrower – like opening a new credit account of paying an existing loan late – can disrupt their credit score and cause the lender to reevaluate the loan and fail to fund it.
OK, so now what? Two options for smart borrowers. First, demand a “funding” contingency in the contract that pushes the risk of non-funding back to the seller and permits the buyer to terminate the contract and get a refund of the contract downpayment in the event of a non-funding. Or, second, negotiate a compromise with the seller in the contract, and instead of forfeiting 10% of the purchase price, offer the seller a termination fee that is more reflective of the seller’s actual damages (losing time in the marketplace) of perhaps $5,000 or $ 10,000 if the buyer needs to terminate for lack of financing. Still a hefty sum, but far better than the typically 10% of the purchase price which most contract routinely require.