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Loan Contingencies Require Careful Attention

Written by Posted On Friday, 21 December 2007 00:00

When directors of the California Association of Realtors® meet for the conduct of association business, there are always "hot topics" being discussed in the hallways, at regional caucuses, and in the meetings of various committees. At their recent meetings in Anaheim, one of the topics d'jour -- especially at committees dealing with legal and transactional issues -- was that of loan contingencies.

The standard California purchase contract provides for a variety of contingencies. The purchase agreement is typically contingent on such things as the buyer receiving satisfactory inspection reports, a termite clearance, acceptable governing documents if an association is involved, etc. Some contingencies have to do with financing. There may be a contingency that the property must appraise for the agreed purchase price. In the case of loans, the contract language is this: "Obtaining the loans [specified in the offer] is a contingency of this Agreement … [unless agreed otherwise]."

For most contingencies, by default their removal is to occur within seventeen days, although the time period may be changed by agreement. For example, a buyer might need 28 days before he could remove a contingency regarding a geological inspection.

The loan contingency is different in this regard. The contract specifies: "(i) Within 17 (or ? __) Days after Acceptance, Buyer shall, as specified in [a following section], remove the loan contingency or cancel this Agreement; OR (ii) (if checked) the loan contingency shall remain in effect until the designated loans are funded." There is a third option. The contingency may be removed within 17 days, or it may last longer, OR it may run until the loans are actually funded -- essentially, until the close of escrow.

In "normal times" -- whatever exactly those may be -- the third option is seldom agreed to by the seller or insisted upon by the buyer.

If an escrow is 30 to 45 days or more, the seller doesn't want to wait until the end to be assured that the buyer is able to get the loan. The contingency is typically the default 17 days, or maybe up to 25. Generally, it is no problem for a buyer to remove this contingency, given that they will receive loan approval within that time.

These days, however, receiving loan approval -- even "formal" loan approval - doesn't carry the weight that it traditionally has. (People who were around in the early 1980s will remember this phenomenon.) Today, a lender may approve Mr. and Mrs. Jones for a $350,000 loan at x% interest, but, two weeks from now, the interest rate may have changed, or the loan program no longer exists, or (it happens) the lender may no longer exist.

Clearly, this is a problem for both parties. The lender wants to sell, but now his buyer doesn't have financing. The buyer wants to buy, but now he doesn't have a loan. Moreover, for the buyer, if he has removed his loan contingency, his good-faith deposit may be at risk also.

Many brokerage counsels are advising buyers' agents that their clients ought not to remove loan contingencies prior to the close of escrow (i.e. until funding). They should take the third option. If the seller won't go for this, perhaps the buyer can negotiate a modification of the terms, so that their deposit won't be at risk in the event of "lender failure." Or, buyer and seller might agree that, if there is "lender failure," the buyer will have an additional amount of time to secure financing elsewhere.

The problem here is that crafting the language of such agreements can be tricky. In many cases it is probably something most agents shouldn't try to do on their own. They should be consulting with their managers and/or company attorneys.

Other practices that some brokerages are now insisting on include (1) Don't use lenders that are unknown to the brokerage and its agents, (2) Require that buyers make applications with two lenders, so that there is both a back-up available, and a double check on qualification, and (3) insist on a true commitment letter from the lender, not just a contingency-laden approval letter, before a buyer removes the loan contingency.

There are no perfect answers here. There are risks for both sides. But buyers want to buy and sellers want to sell. Both agents need to work together to make that happen.

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Bob Hunt

Bob Hunt is a former director of the National Association of Realtors and is author of the recently published book, "Real Estate the Ethical Way." A graduate of Princeton with a master's degree from UCLA in philosophy, Hunt has served as a U.S. Marine, Realtor association president in South Orange County, and director of the California Association of Realtors, and is an award-winning Realtor. Contact Bob at scbhunt@aol.com.

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