Question: We just signed a contract to buy our first home. Because of the crazy real estate market, we included an escalator clause in our offer. Apparently, there were three other offers made to the seller, but our price (based on the escalator clause) was the highest. We do not have a contingency for financing, although we will need to get a loan in order to purchase the property.
We applied for a 90 percent adjustable rate mortgage. Our mortgage lender has just advised us that the house appraised $30,000 lower than the contract price, and that our loan will be less than we requested. What should we do?
Answer: You will not be happy with my answer. You made one major mistake: you did not have a financing contingency in your contract.
I understand that real estate brokers are advising potential purchasers that if they include a financing contingency in their contract offer, that sellers will reject that proposal. The reason is that since the market is currently hot, sellers do not have to accept contracts which are contingent. Since there are a lot of people like you who are willing to take a chance and make offers which are absolutely clean, why should the seller take the house off the market even for a few days while waiting to determine if the buyer can obtain the necessary financing?
There is a lot of talk nowadays about the possibility that the "bubble" will burst, and that real estate prices will either level off or drop. I am neither an economist nor a fortune-teller, so I am unwilling to make any predictions along these lines. However, I strongly believe that unless potential buyers are absolutely certain that they can obtain the necessary loan to buy the house, every real estate contract must contain a contingency for financing.
This simply means that after the sales contract is accepted by the seller, the buyer has X number of days in which to get a firm loan commitment from a mortgage lender. It should be noted that many lenders will provide the buyer with a "preliminary loan letter." This says that based on the financial condition of the buyer, the lender is satisfied that the buyer can qualify for the requested loan. I call this a "comfort letter."
You must read that letter carefully, however. It is not a firm, binding commitment. It generally will contain one important caveat -- namely that the loan is subject to the lender obtaining a satisfactory appraisal of the house.
Let's take this example: your contract price is $400,000, and you applied for a 90 percent loan in the amount of $360,000. You were going to put down $40,000 of your own money (i.e. 10 percent). The appraisal, however, came in at $370,000. Your lender will only lend you $333,000, which means that you will now have to come up with $67,000 in order to purchase the property.
Obviously, this can be a real problem, and if you do not go to settlement, your seller may opt to declare you in breach of your contract, and try to keep your earnest money deposit.
What should you do? First, I would talk with your lender, and obtain a copy of the appraisal. Perhaps there were errors that might increase the valuation. After all, an appraisal is not an exact science, and appraisers can make mistakes.
Second, explore other options with your lender. While I do not favor loans which are 100 percent of the purchase price, in your case this may be the only way to save your deposit and allow you to go to closing.
If your mortgage lender is reluctant to reassess the situation or is unwilling or unable to find alternative solutions, then I suggest that it may be time for you to find a new lender. You probably will have to pay another application fee.
When you go to the new lender, however, describe the background of your earlier application. It is possible that a new lender will be able to use some of the information already obtained from the previous lender, thereby saving you some money and possibly speeding the loan process.
You should also immediately explain the situation to the seller, and to any real estate agents involved in the transaction. If the market is really hot, and there are other potential purchasers, perhaps the seller will be willing to immediately release you (and return your deposit) so that they can sign a contract with another buyer. However, the longer you wait, it will be harder for the seller to cooperate with you.
Buying a home is not like going to a supermarket. Purchasers must understand that when they sign a sales contract, it is a legally binding document. Contingencies -- such as financing and home inspection -- are common in the industry. Do not get carried away with the frenzy of today's marketplace. Take your time before you sign a contract. Would you rather lose that nice house, or lose your hard-earned earnest money deposit?
