Know risks before waiving a financing contingency
Low appraisal can be bad news for buyers
Certain situations can steer buyers off the recommended course of action when making an offer. One is a multiple-offer competition. Another is stubborn sellers who buyers are trying to soften up enough to agree to sell them their home.
Normally, unless the buyer has all cash and doesn’t need a mortgage, a purchase contract will include a contingency for arranging financing. The contingency is pegged to a deadline, often two to three weeks. Sometimes it can take longer, depending on the complexity of the buyers’ financial situation and the backlog in the lender’s underwriting system.
In order to approve a loan, the lender needs a copy of a purchase contact signed by the buyers and sellers, a satisfactory search of the title record, an acceptable appraisal of the property and acceptance of the buyers as creditworthy to borrow the amount they are requesting.
If the buyers try in earnest but aren’t able to satisfy the above conditions, their deposit is usually refunded and the house goes back on the market. An offer that doesn’t include this protection for the buyers is attractive to most sellers.
HOUSE HUNTING TIP: The ease with which you’ll be able to gain confidence that you don’t need a financing contingency has to do with the lender or mortgage broker you choose to work with. For instance, if you bank with an independent bank that holds a lot of your money and knows your cash flow situation, you’ll have less to be concerned about than if you’re working with a big institution that doesn’t know you and has a multilayered, inefficient underwriting procedure.
Some buyers who are well-qualified to support monthly mortgage payments have been turned down by banks for foolish reasons. For example, one man wanted to refinance to a lower loan amount after selling a multimillion-dollar business. His credit was pristine. The lender didn’t like that he didn’t have an income. He went to an independent bank that was happy to have his business and they did the loan.
Appraisals pose another set of problems. If the appraisers are unfamiliar with the local market, their appraised value can be way off, usually on the low side.
Lenders loan money based on the appraised value of the property, not on the purchase price in the contract. A low appraisal can pose a problem for the buyers if they aren’t protected by a financing contingency.
For example, let’s say a lender has agreed to loan you 80 percent for the purchase of a $500,000 home as long as you make a down payment in the amount of 20 percent of the purchase price. If the home appraises for $450,000 instead of $500,000, the lender will probably still give you a mortgage for 80 percent of the appraised value, but the loan amount — $360,000 — is $40,000 shy of what you need to make the deal at $500,000.
If you were protected by a contingency, you could withdraw without penalty or try to negotiate a price reduction with the seller. Without a contingency, you could lose your deposit if you back out of the deal based on the low appraisal.
A fluctuation in current market value has an effect on comparable sales prices. Last month’s comparables may be out of sync with current pending sale prices, increasing the odds that a listing might not appraise for the contract price.
In the Silicon Valley area of Northern California, the inventory is so low and incomes so high that listings are sometimes selling for hundreds of thousands of dollars over the list price. Some listing agents make sure the appraisal contingency is waived before an offer is accepted to protect the seller from a failed transaction.
THE CLOSING: Before waiving a financing contingency, make sure you understand the risks you may face.