Trends in Mortgage Contingency Clauses
Most people looking to purchase a new house or apartment will need financing. This is the reality for most that make a foray into the real estate world. However, sellers hate financing because it could be a major stumbling block for the deal. In most real estate contracts that involve financing, the purchaser is given a mortgage contingency that provides the purchaser with a refund of the contract deposit if the purchaser cannot obtaining financing after a good faith effort. Mortgage contingencies can be extremely frustrating to sellers as they provide a means for purchasers to escape purchase contracts, temporarily take the property off the market and provide no compensation to the seller for the lost time.
With the New York City real estate market seeing extreme demand pressure, sellers have been using this leverage to employ new tactics to diminish the protections provided to purchasers in mortgage contingency clauses.
Mortgage Contingency Clauses that require application to a lender of the Seller’s choice.
Purchasers can sometimes escape purchase contracts by going to a lender that refuses to make a loan because it disapproves of the property. Sellers have begun to combat this tactic by including a clause in the purchase contract requiring purchasers to go to a lender that has already pre-approved the building.
When a lender evaluates a mortgage application, the lender will look at both the borrower and the property. The lender may find that the purchaser is credit worthy but determine that the property does not fit its criteria for a mortgage loan, and thus reject the mortgage application.
A property can be rejected by a mortgage lender for a variety of reasons, and rejection does not necessarily mean that the property is a poor investment. For instance, Fannie Mae lenders have very strict guidelines as to which properties it will approve for mortgages. With apartment sales, Fannie Mae will not approve buildings that have one entity owning more than 10% of the units or have commercial space that comprises greater than 20% of the building. Although these requirements are in place to ensure safe lending practices, many NYC apartments will not meet Fannie Mae’s lending criteria but still be great investments.
Purchasers that have buyer’s remorse will sometimes go to a strict lender in order to get rejected for a mortgage and renege on a purchase contract. However, now that sellers have greater leverage, they have been able to negotiate a caveat into mortgage contingency clauses that require the buyer to go to a lender that has already pre-approved the property. As long as the purchasers is credit worthy, this caveat prevents purchasers from being able to slip the purchase contract by going to an overly strict lender that rejects the property. It should be noted that the purchaser can still use a lender of their choosing, but if they are unable to find one, they will have to end up using the lender chosen by the seller.
This caveat in mortgage contingency clauses are great for the seller because it protects them from purchasers unfairly jumping ship. It should also be noted that its not necessarily a bad deal for purchasers either as having a lender in place that has already pre-approved the building can save a purchaser time in finding a lender.
Some purchase contracts have done away with mortgage contingency clauses all together.
Another practice that has become more prevalent with increased sellers’ leverage is the exclusion of mortgage contingency clauses from purchase contracts all together. Generally, sellers prefer all cash deals, but removing the mortgage contingency provides sellers with the next best alternative. By removing the mortgage contingency from a purchase contract, sellers are able to retain a purchaser’s contract deposit if the purchaser is rejected for financing.
Entering a purchase contract without a mortgage contingency can be dangerous for purchasers. The mortgage contingency clause is there to protect purchasers in the event the purchaser’s lender refuses to facilitate the transaction. As discussed above, lenders primarily reject purchasers based on either the purchaser’s creditworthiness or the building’s financial condition. In most real estate transactions, lenders typically don’t do an in-depth analysis of the building’s financials till after the contract is entered into. This leaves purchasers that have no mortgage contingency in a precarious position. The purchaser’s credit may be good, but the lender can still reject the transaction because it disapproves of the building’s finances.
There are ways for purchasers to protect themselves in situations where they must enter a contract without a mortgage contingency clause. The purchaser should go to his or her lender before entering the contract and see if the building is already pre-approved or if the lender can check if the building is approvable. Most lenders will do this for customers as a courtesy.
Although entering a contract without a mortgage contingency clause can be risky, it may be the only way to get your ideal property. Before doing so, you should consult with your lender and attorney to make sure it’s the right situation for you.
If you ever find yourself with a question about mortgage contingency clauses or real estate law generally, please feel free to contact the NYC real estate attorneys at the Kanen Law Firm.