Over the summer our local real estate market which includes the cities of Palo Alto, Menlo Park, Los Altos and even communities further north like San Carlos has continued to move at an exhilarating pace. Well-priced and presented homes are selling quickly, and often, in fact, almost always in multiple offers. As we work with our buyer clients preparing offers for these competitive situations, we are always asked: “If I’m pre-approved for my loan, do I need a financing contingency?”
Buyers should be pre-approved for their financing.
In an earlier post in October, 2010 Successful Buyer Strategies (http://carolandnicole.com/blog/page/11/), we discussed the importance of connecting with a lender early in the process of buying a home. In our competitive market place, it is essential for buyers to be pre-approved for their financing. A pre-approval letter from a local, reputable lender is based on verification of the buyers’ credit history, income/employment history and assets to confirm the sufficiency and availability of the down payment and closing costs. A seller in our market area will expect that their buyer be financially qualified before entering into a purchase contract because it effectively results in “taking the home off the market” until the close of escrow.
When writing an offer, buyers should carefully consider the value of having both appraisal and financing contingencies as part of the purchase contract, and prior to releasing these contingencies buyers and the agent representing them should work closely with the lender to understand all of the “pre-funding” conditions to ensure that they can be met. It’s equally important for sellers to understand that even after buyers have removed conditions occasionally underwriters raise concerns over which buyers may not have any control.
“Pre-Qualification” vs. “Pre-Approval”
There can be confusion over the terms “pre-qualification” and “pre-approval”. Rarely is a pre-qualification letter sufficient to satisfy a seller because a lender has not yet verified any of the information submitted by the buyer. To add further complication to the terminology, occasionally – and more often than you’d think – a lender issues a letter or certificate boldly labeled: PREAPPROVAL. However, in reading the fine print, the exceptions to the “pre-approval” are verifications of the buyers’ income, employment, assets and credit!
Financing & Appraisal Contingencies
In our local area the purchase contract provides two related but different contingencies concerning financing: Financing and Appraisal. When a pre-approval letter is issued by the lender there are a few conditions relating to the final approval and typically these are the lender’s receipt of a ratified purchase contract, a preliminary title report and a satisfactory appraisal report. The appraisal report is completed by a certified appraiser, and is an “arm’s length” transaction. The lender orders the appraisal from an appraisal management company that assigns a qualified appraiser to the purchase. The appraiser determines the “Current Market Value” based on comparing the purchased property to recent properties sold and some that have “pending” sales. The lender calculates the loan amount on the lower of the purchase price or the appraised value. If the purchase contract contains an appraisal contingency, and the property does not appraise at or above value then the buyer may withdraw from the purchase contract without penalty.
Current Market Value & Overall Property Condition
In addition to analyzing recent market activity and calculating the “Current Market Value” of the property, the appraiser makes notes about the overall condition of the property, documents this with photographs, and comments on overall market conditions for the area. Of particular note is what might be considered health and safety issues. There are situations, albeit rare ones, when a property appraises at value, but based on input by the appraiser actually obtaining the loan requested has been problematic.
In the past two years, we have been involved in 3 situations where the lack of hand railings on a deck and the spacing of balcony rails in condominium complexes became concerns of the lender. In the first situation the buyers’ lender would not fund the loan until a hand railing was installed on a deck that was built over a hillside and did not have adequate railings that would prevent someone from falling. Fortunately, the seller was willing to allow the buyer access to the property prior to the close of escrow to install this railing. Photographs were taken and sent to the underwriter who eventually authorized funding of the loan. In two other instances, resolution was more complicated due to the fact that the railings were “owned” by the association consequently the individual unit owner could not modify the “common area”. In both instances the lenders’ concerns were about the spacing of the balcony rails. In one situation we were able to “reason” with the lender who eventually funded the loan after a two-week delay. In the second instance the association allowed a temporary protective net to be installed and the loan funded based on a re-inspection of the rails.
While we were not personally involved in this situation, we recently learned of a transaction where the appraisal report supported the purchase price, but the appraiser determined that the neighborhood where the home was located was considered “declining”. On this basis the lender indicated their willingness to lend, but required that the buyer put more than 20% down. The buyer was not able or unwilling to do this and cancelled the purchase contract based on the inability to obtain the loan amount stipulated in the purchase contract.
Contingencies can be tricky business.
With experience on more than 1,000 transactions, Carol & Nicole know what it takes to work collaboratively to help ensure that all parties, including the lender, are satisfied.