Tuesday, January 10, 2012

Negotiating a Mortgage Contingency

Most buyers require a mortgage to buy an apartment in NYC. Mortgage lenders typically require 30-60 days to process a loan application, complete the appraisal, review title and fund a loan, most sales contracts between buyers and sellers include a mortgage contingency clause. Buyers should pay close attention to the terms of that mortgage contingency before signing contracts so they can be prepared if a problem develops with their mortgage.

What is a Mortgage Contingency?

A mortgage contingency clause generally states the buyer will have a certain number of days from the time of signing the sales contract to obtain a mortgage commitment. The buyer is expected to make a good faith effort to obtain an application to apply for a mortgage.

Why a mortgage contingency is needed?

Buyers and sellers might ask the question: If a home buyer has to be pre-approved for a mortgage before a seller will accept an offer, why does the seller need to give the buyer a mortgage contingency at all? The main reason is pre-approvals are for the individual and not for the property, which is a key part of any mortgage loan approval. Mortgage lenders need to complete and review an appraisal of the property in addition to reviewing the title report before they are willing to issue a full mortgage commitment.

The second reason buyers need a mortgage contingency period in a contract is because pre-approvals are often subject to final verification of a borrower's documentation supporting their application. The lender needs time to collect, review and accept this documentation. Also, given the current lending environment, as a buyer, it makes sense to negotiate a contingency to protect yourself against losing your 10% earnest deposit monies if for some reason you are unable to secure a loan.

Buyer's Market

In the buyer's market of today, sellers are more than willing to give buyers a reasonable mortgage contingency period - usually 30 to 45 days. In addition, during periods where lenders are extremely busy and approvals take longer, buyers can usually obtain short extensions to the contingency as long as the seller is confident that the buyer is making progress on their mortgage.

Seller's Market

In a seller's market, however, buyers are lucky if they can get a mortgage contingency clause at all. When buyers are bidding against each other in a bidding war, many buyers are willing to gamble they will get there mortgage approved and sign a contract without any mortgage contingency at all. This means if the buyer does not get a mortgage they will not get the house and they will also lose whatever earnest deposit money they put down.

Negotiating a Mortgage Contingency

A purchasers request for a mortgage contingency doesn’t mean his/her financials aren’t strong. In many instances, not allowing a financing contingency may end negotiations with a Purchaser even though the chances of a Purchaser not obtaining financing are minimal. A seller’s real estate broker can reduce the risk to a Seller who gives a mortgage contingency by evaluating the following and tweaking the terms of the contingency: the purchaser’s finances, building financials and the lender’s requirements. They can also negotiate a lower percentage of allowable financing:

1. Negotiate a bi-furcated mortgage contingency, i.e. contingent on the lending institutions approval of the building’s financial condition.

2. If the purchaser can’t get a loan, the seller can keep a portion of the earnest deposit.

3. If Purchaser can’t get a loan, purchaser must apply to a 2nd lender chosen by Seller.

Negotiate a shorter time period for the Purchaser to obtain a loan commitment.

A few suggestions for buyers:

Home buyers should take a close look at the mortgage contingency clause in any contract they sign. There are three main problems usually not covered by standard mortgage contingencies:

1. You do not lock your mortgage rate or your mortgage rate expires. Most mortgage contingency clauses state as long as a home buyer obtains a mortgage at the "prevailing rate" then they are considered to have met the contingency and the buyer is stuck buying the apartment. If you do not lock your interest rate and rates spike up after you sign the contract but before the mortgage contingency is up, you may be forced to buy the house with a high interest rate and not be able to cancel the transaction.

2. What if your lender goes out of business before closing? In the past two years, hundreds of mortgage bankers have gone out of business. Buyers who had passed the date of their mortgage contingency and not yet closed with mortgages from these lenders were left hanging with no mortgage and a contract obligation to close on the purchase within a certain period. To avoid this add a clause that allows the buyer additional time to secure a loan with a second lender.

3. A documentation issue arises between mortgage contingency date and closing. Often, lenders find an additional document that they need right before closing when they do a final review of documents. If the buyer cannot provide the documentation, then the loan is denied. To avoid this situation, make every effort to get all conditions on your mortgage approval cleared before your mortgage contingency date.

Whether buying or selling, make sure your real estate attorney understands the real risks associated with the deal to avoid any major concerns and reduce your associated risks while keeping the deal alive.