Friday, November 9, 2012

Contract for Sale and Purchase: Financing Contingency

Real Estate contracts can be long intimidating documents filled with language that most people cannot or would prefer not to decipher.  It is a legally binding agreement with a host of obligations built into the provisions that you as a buyer or seller need to understand before signing.  There is an important clause found in every real estate contract that states, “This is intended to be a legally binding contract.  If not fully understood, seek the advice of an attorney before signing.”  We encourage parties to a real estate transaction to seek the advice of an experienced real estate attorney, but we want to help explain a key element of every contract today.

Contingencies

When the buyer and the seller agree to the terms of the transaction and sign the contract, the deal is almost always far from over.  Real estate agents will oftentimes refer to this phase as “contingent.”  A buyer will almost always have at least one contingency built into the contract so that despite the fact he has signed a contract, he can still cancel the contract without losing his earnest money.  One caveat being that in certain situations, a seller might require a buyer to deposit earnest money that is non-refundable for one reason or another.  In this situation, the buyer might still have the right to cancel the contract if a particular contingency is not satisfied, but the earnest money would be lost.  There are several contingencies that are common to most contracts, but today we are focusing on the financing contingency.

Financing

Different financing contingencies might have different specifics, but the general concept is that the buyer is only obligated to go through with the purchase if he is able to obtain the necessary financing to make the purchase.  Many contracts have blanks so that the buyer will fill in the type of financing he hopes to obtain along with the terms of the loan.  Other contracts might simply say that the buyer hopes to obtain a loan for the purchase according to the prevailing rates at the time he or she applies for financing.  We have even seen contracts where the buyer simply says he is financing the property and lists no other specifics giving him the option to pursue any loan possible to close the deal.

In order to get financing approval from a lender, the buyer will have to show that he is financially able to perform under the terms of the loan and the property must meet certain requirements to prove it is a sound investment on the lender’s part.  The buyer must make a diligent effort to obtain financing.  The property must appraise for the sales price, otherwise the lender will refuse to loan the full amount needed.  If these two requirements are not met and the loan is denied, then as long as the buyer has complied with the time limits and other provisions of the financing contingency, he may be able to cancel the contract and get back any earnest money.  This does not mean that the deal has to die.  If the appraisal comes in lower than sales price, the buyer and seller can try and reduce the sales price to allow for financing approval.  The buyer could also agree to pay a larger part of the purchase in cash to compensate for the lower loan amount.  These are not required steps, but could work as options if both parties are determined to get the deal to close.      

A financing contingency can be a turn-off for some sellers.  An overpriced property has little chance of appraising for the sales price if no other comparable sales in the area support such a high price.  The seller might be reluctant to agree to a contract contingent on financing because the property is not being marketed for sale while the buyer is trying to get the financing together.  The seller might miss out on a cash buyer in this time period.  Of course the seller must make a decision to either sell for a lower price so that the buyer can get financing approval, or hold out for a higher offer that must be cash in order to close.

Financing contingencies are important for many reasons including the fact that real estate loans were such a huge factor in the economic downturn over the last couple of years.  Real estate financing has become a hot topic for debate as the housing market finally starts to improve.  Loans are still not as easy to come by for many buyers as in previous years, but that is starting to change.  If both sides of the transaction have done their homework, then there should not be a question on whether or not financing will be approved.

Many financing questions are best directed to the lenders as legal questions are best directed towards an attorney.  It is important to at least understand how different contractual provisions work either for or against you.  In future blogs we will address other contract contingencies such as inspections, zoning for specific use and other sales occurring first.

Please See Our Related Blogs:
Why Purchase Property under an LLC?
Turning the Corner on the Housing Market?

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