Navigating the Financing Contingency in a Competitive Market

Residential Real Estate Attorney Guide Financing Contingency

Although financing contingencies are becoming less common in this competitive market, they are still an important term that often is part of the final contract. But it’s important to avoid some common mistakes when negotiating these provisions or your client could end up inadvertently putting themselves in a compromised position.

Loan To Value It Too Low: In the back and forth in a negotiation, a seller often will agree to provide a financing contingency to the buyer, but only if the buyer puts more equity into the deal, thus decreasing the maximum loan to value (“LTV”) that the buyer is permitted to apply for under the contingency language. Be careful here, that’s not always a smart move. Generally, the lower the LTV, the easier it is for a buyer to qualify. But sometimes forcing the LTV too low will actually give the buyer a way out of the contract and the seller may not even realize what they have done. An example will help illustrate this:

“Bob is prequalified for an 80% loan on a $450,000 condominium. The prequalifying bank has vetted his credit score, and reserves, and is confident that he will be approved for this loan. But during the negotiation, the seller agrees to a contingency, but only at 70%, thinking that the lower LTV (with the corresponding higher down payment) will make it more likely that Bob will be approved. And usually that is true. But in this case, Bob’s post-closing liquidity at 70% LTV (30% down) is actually too low and will cause him to get rejected for the loan. At 80% LTV he would be approved, given the 20% down payment leaves him enough post-closing liquidity. So, inadvertently, the seller has actually created a situation where Bob has an “option” to terminate the deal at the end of the contingency period and get his contract down payment back.”

Appraisal Issues: Implicit in typical financing contingency language is the requirement that the property appraise at full contract value. But with increasing prices, often appraisals don’t keep up. And bidding wars can produce a price that even the most recent comps will not fully support. So be careful here, have your seller’s counsel include an “appraisal window” which will hold the buyer to the contract notwithstanding a low appraisal. Here’s another example:

“Sue the seller agrees to give Bob the buyer a 50% financing contingency. The purchase price for this condominium deal is $1,000,000, a record for this building. Sue thinks the unit will likely appraise at around $950,000, but is fine with the 50% contingency because if the unit appraises low Bob can always increase the LTV above 50% to yield the same loan. At $1,000,000 price, a 50% LTV loan is $500,000. If the property appraises at $950,000, Bob merely increases his requested LTV to 52.6% LTV, still well within normal guidelines. But is Bob contractually obligated to request this increase? No, and moreover Bob will get a denial letter on his loan application if the price comes in even a dollar below the purchase price! While typically the banker would simply offer to increase the LTV requested, the borrower is not obligated to accept it, and without contractual modification, the borrower is also free to decline this option under the contract and receive a full refund of the contract down payment under a typical financing contingency.”

Signing The Non-Conforming Commitment: A commitment letter conditioned on the appraisal does not satisfy the contingency language until the appraisal is completed (at full value) and accepted by the bank. But be careful here also, the standard form of condominium contract waives this language if the buyer accepts the non-conforming commitment letter (by accidently signing it)! The lesson here: ask the buyer’s lawyer to review it before signing.

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