RESIDENTIAL REAL ESTATE
UNDERSTANDING THE MORTGAGE CONTINGENCY CLAUSE
Once a contract for the purchase and sale of residential property has been signed by both buyer and seller, and the attorney review period has concluded without cancellation of the contract (or with cancellation and reinstatement of the contract), it becomes binding on both buyer and seller. The seller must sell to the buyer, and the buyer must buy, except for CONTINGENCIES.
CONTINGENCIES are conditions which must be satisfied before the parties are obligated to go forward with the purchase. In a residential sale, contingencies are generally included in the contract to protect the buyer against certain possibilities. One of the buyer’s main concerns is that he might not be able to get the financing necessary to make the purchase. In the usual scenario, the buyer cannot be sure he will be able to get a mortgage loan until he and the seller have signed the contract, but once they do so, the buyer is obligated to buy. To avoid this Catch-22, the contract contains a MORTGAGE CONTINGENCY clause. This clause provides that if the buyer can’t get a lender to commit to granting him a mortgage loan, he does not have to go forward with the purchase. The MORTGAGE CONTINGENCY will provide that unless the buyer gets a mortgage commitment in a specified amount within a specified period of time, he has the right to cancel the contract, get his deposit back, and move on. If, on the other hand, the buyer gets the commitment, the deal goes forward.
WARNING! Buyers (and sellers) sometimes assume that the buyer will get the mortgage loan he applies for because a lender has issued him a “pre-qualification letter.” This is not a commitment to lend. It is merely an indication that the buyer has consulted a lender and that the lender believes that if the buyer finds a suitable property, and if the buyer’s loan application and documentation support whatever the buyer has said about his financial situation, the lender will be likely to issue a commitment. A lender is not obligated to issue a loan commitment just because it has issued a pre-qualification letter.
The pre-qualification letter cannot be a commitment to lend because at the time it is issued, the lender simply doesn’t have enough information to make an underwriting decision. In the first place, there is the issue of the property itself. Before making a commitment to lend for the purchase of a property, the lender will appraise the property to be sure it is worth more than the requested loan amount. Even if the buyer has sufficient income to repay a giant loan, the lender will not lend more than a certain percentage of the value of the property and of the purchase price. So, no loan application is complete without a copy of the fully signed contract identifying the property and establishing the purchase price.
The second issue which the lender must consider in its underwriting decision is the income, assets and credit-worthiness of the buyer. While the pre-qualification letter is usually based on what the buyer tells the lender about his financial situation, the loan application will require supporting documentation substantiating the buyer’s income, assets and expenses. The lender will do credit checks on the buyer and will often ask the buyer for additional documentation or clarification.
Once the loan application and appraisal are complete, the lender’s underwriting committee will approve the loan and issue a commitment (or not). The commitment will be for a loan in a specified amount for the purchase of a specific property at the specific purchase price. It will have a time limit, and will include various conditions which have to be fulfilled before the lender will disburse the funds for the purchase.
Once the buyer receives the commitment letter, the mortgage contingency has been satisfied. Sometimes the buyer will not obtain either the commitment or a denial of the loan application within the time limit set forth in the sale contract. In that case, the contract usually provides that the buyer or seller can cancel the contract. Often, it is in both their interests to extend the time period of the mortgage contingency, particularly when they believe that a commitment is imminent. If the buyer is turned down by the lender, he also has the option of waiving the contingency, which means that he will be obligated to purchase without a mortgage loan. Few buyers are in a position to do that.
Once the loan commitment has been issued or the contingency waived, the parties proceed with the contract towards the next contingency, the INSPECTION CONTINGENCY. That’s the subject of next week’s handout.
DISCLAIMER – This article is for general information only and is not intended to provide legal advice or to address specific legal problems. This article does not create an attorney-client relationship. For legal advice concerning real estate transactions and all other legal matters, consult an attorney.
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Residental Real Estate – Mortgage Contingency Clause
RESIDENTIAL REAL ESTATE
UNDERSTANDING THE MORTGAGE CONTINGENCY CLAUSE
Once a contract for the purchase and sale of residential property has been signed by both buyer and seller, and the attorney review period has concluded without cancellation of the contract (or with cancellation and reinstatement of the contract), it becomes binding on both buyer and seller. The seller must sell to the buyer, and the buyer must buy, except for CONTINGENCIES.
CONTINGENCIES are conditions which must be satisfied before the parties are obligated to go forward with the purchase. In a residential sale, contingencies are generally included in the contract to protect the buyer against certain possibilities. One of the buyer’s main concerns is that he might not be able to get the financing necessary to make the purchase. In the usual scenario, the buyer cannot be sure he will be able to get a mortgage loan until he and the seller have signed the contract, but once they do so, the buyer is obligated to buy. To avoid this Catch-22, the contract contains a MORTGAGE CONTINGENCY clause. This clause provides that if the buyer can’t get a lender to commit to granting him a mortgage loan, he does not have to go forward with the purchase. The MORTGAGE CONTINGENCY will provide that unless the buyer gets a mortgage commitment in a specified amount within a specified period of time, he has the right to cancel the contract, get his deposit back, and move on. If, on the other hand, the buyer gets the commitment, the deal goes forward.
WARNING! Buyers (and sellers) sometimes assume that the buyer will get the mortgage loan he applies for because a lender has issued him a “pre-qualification letter.” This is not a commitment to lend. It is merely an indication that the buyer has consulted a lender and that the lender believes that if the buyer finds a suitable property, and if the buyer’s loan application and documentation support whatever the buyer has said about his financial situation, the lender will be likely to issue a commitment. A lender is not obligated to issue a loan commitment just because it has issued a pre-qualification letter.
The pre-qualification letter cannot be a commitment to lend because at the time it is issued, the lender simply doesn’t have enough information to make an underwriting decision. In the first place, there is the issue of the property itself. Before making a commitment to lend for the purchase of a property, the lender will appraise the property to be sure it is worth more than the requested loan amount. Even if the buyer has sufficient income to repay a giant loan, the lender will not lend more than a certain percentage of the value of the property and of the purchase price. So, no loan application is complete without a copy of the fully signed contract identifying the property and establishing the purchase price.
The second issue which the lender must consider in its underwriting decision is the income, assets and credit-worthiness of the buyer. While the pre-qualification letter is usually based on what the buyer tells the lender about his financial situation, the loan application will require supporting documentation substantiating the buyer’s income, assets and expenses. The lender will do credit checks on the buyer and will often ask the buyer for additional documentation or clarification.
Once the loan application and appraisal are complete, the lender’s underwriting committee will approve the loan and issue a commitment (or not). The commitment will be for a loan in a specified amount for the purchase of a specific property at the specific purchase price. It will have a time limit, and will include various conditions which have to be fulfilled before the lender will disburse the funds for the purchase.
Once the buyer receives the commitment letter, the mortgage contingency has been satisfied. Sometimes the buyer will not obtain either the commitment or a denial of the loan application within the time limit set forth in the sale contract. In that case, the contract usually provides that the buyer or seller can cancel the contract. Often, it is in both their interests to extend the time period of the mortgage contingency, particularly when they believe that a commitment is imminent. If the buyer is turned down by the lender, he also has the option of waiving the contingency, which means that he will be obligated to purchase without a mortgage loan. Few buyers are in a position to do that.
Once the loan commitment has been issued or the contingency waived, the parties proceed with the contract towards the next contingency, the INSPECTION CONTINGENCY. That’s the subject of next week’s handout.
DISCLAIMER – This article is for general information only and is not intended to provide legal advice or to address specific legal problems. This article does not create an attorney-client relationship. For legal advice concerning real estate transactions and all other legal matters, consult an attorney.