Question: I think we are in trouble. Three weeks ago, we signed a contract to purchase a single-family house. Our real estate broker told us that there was a lot of interest in the property and if we really wanted to buy we should not put any contingencies into our contract offer. We thought that we could qualify for a mortgage loan, and took the broker's advice. It now turns out that our credit score is too low and our mortgage lender has turned us down for the loan.

We put up a $20,000 earnest money deposit, and are now concerned that we may lose this money -- as well as the house -- if we are unable to get a loan.

Are we in trouble?

Answer: Yes, you may be in serious trouble if you cannot salvage the deal. There are two very important buyer provisions which should be contained in every real estate contract: a financing contingency and a home inspection contingency.

A contingency is defined as a stated event spelled out in the contract, which must occur before a real estate contract is binding. Let's look at both of these contingencies:

Financing: You are purchasing a house for $300,000, and plan to get an 80 percent loan, in the amount of $240,000. That means that you have to make up the 20 percent difference ($60,000) with your own cash, in addition to the various closing and lender charges which will occur at settlement. The monthly mortgage payment for a $240,000 mortgage, based on a 6 percent rate, amortized over 30 years will be $1438.94. You also will have to pay real estate taxes and insurance, which could cost you $300-400 more a month.

Mortgage lenders have formulas whereby they can determine whether a potential buyer can qualify for a loan. Obviously, a lender does not want to lend money to a person who just cannot afford the monthly payments. All legitimate mortgage lenders do not want to foreclose on your house; they want you to be successful with your new home purchase.

You should have talked to a mortgage lender before you signed the contract, to determine whether you can, in fact, qualify for a loan. Most lenders will give you a preliminary (comfort) letter, which states that subject to an accurate appraisal of the property, based on the financial information you have provided the lender, you can qualify for a loan up to a certain amount.

You should never give that comfort letter to a seller until after you sign the contract. Why not? If, for example, you are negotiating the sales price, and the seller learns from the comfort letter that you can qualify for a higher purchase price than you are offering, the seller may not be so inclined to negotiate the sales price down.

But, the comfort letter should be in your hands, so that you know approximately how much money you can borrow.

Your sales contract must contain a provision that the contract is contingent -- for a period of days (usually 20-30) -- upon your ability to get the appropriate financing. During this contingency period, your lender will appraise the property and evaluate your credit. If you qualify, you will get a loan commitment letter. If you do not qualify, the lender is required by law to give you a rejection letter. That rejection letter must be given to the seller (or the seller's agent) before the contingency period ends. If the time deadlines are not met, you will have to purchase the property or possibly forfeit your earnest money deposit.

Home Inspection: Are you a structural engineer? Do you have experience with home construction? If not, you must include a contingency that gives you a period of time (usually 7-10 days) after the contract is signed to have the house inspected. If you are dissatisfied with the inspection report, and you advise the seller within the contingency period, you can either terminate the contract and get your deposit back or negotiate some credits with the seller so as to compensate you for the inspection deficiencies which you will have to correct, at your expense.

Now, let's look at your specific situation. Your contract did not contain a financing contingency and you cannot get a loan. Under the standard real estate contract, you stand to lose your deposit.

However, you should immediately explain the situation with your seller. I would talk directly to the seller, rather than have the real estate brokers talking to each other. It may very well be that the seller has other offers (indeed some that may be higher than your contract price) in which case the seller will release you from the contract and return your deposit to you.

If the seller is uncooperative, here are some other suggestions:

• Ask your lender to reconsider. Lenders are willing to take greater risks for higher interest rates. Depending on the rate, you probably will be better off paying a little more money each and every month for your mortgage payment rather than lose your deposit.

• Immediately look for other mortgage lenders. Lenders have a multitude of mortgage programs, and perhaps one of these will meet your needs.

• Do you have any friends or relatives who will be willing to either co-sign on the loan with you or at least guarantee payment on your loan should you be in default?

• Finally, consult your attorney. There may be some technical glitches in the sales contract which would give you the right to claim that the contract is invalid and that you should get a return of your deposit.

You must always include these two contingencies into your sales contract, or you may be faced with a serious loss of money.

Published: June 21, 2004

Use of this article without permission is a violation of federal copyright laws.