Finance contingency clauses in contracts of sale.
This article will explore the issues for both purchasers and sellers in connection with the finance contingency clause.
The Finance Contingency Clause
The accepted practice amongst attorneys in the industry is to use the Blumberg Form of contract of sale. Blumberg prints a form for the sale of a co-op apartment and a condominium unit. Each form contains, as part of its printed form, a clause providing that the purchaser or seller has the right to cancel the contract if the purchaser does not obtain a written loan commitment in a specified period of time. The financing contingency clause, in substance, contains the following obligations:
* The purchaser must apply for a loan within seven (business) days after the contract is fully executed by both parties and returned to the purchaser.
* The clause will indicate what type of loan the purchaser is attempting to obtain (eg. a 30-year fixed rate loan at the prevailing rate of interest).
* The clause will provide how much money the purchaser wants to borrow.
* The purchaser must provided any and all documents requested by the lender in order to obtain a loan commitment letter.
* The purchaser is given between 30 to 45 days to secure a written loan commitment letter (this time period is determined when the contract is negotiated).
* In the event the purchaser is unable to obtain a written loan commitment within the stated time period, either the seller or the purchaser can cancel the contract upon written notice, and the down payment must be refunded.
* If the purchaser or his or her attorney does not notify the seller or the seller's attorney that they have been unable to secure a written loan commitment within the stated time period, the contract provides that the purchaser has waived his or her right to cancel the contract and must continue to proceed to closing, or the purchaser shall forfeit the down payment.
The Blumberg contract defines a "loan commitment letter" as a written offer to make a loan to the purchaser contingent upon a satisfactory appraisal. If the appraisal equals or exceeds the purchase price, the purchaser must proceed with the transaction. If the appraisal comes in below the sales price, the purchaser may have the opportunity to cancel the contract because the lender will not make a loan in the amount applied for by the purchaser.
The Blumberg contract also provides that the purchaser must apply to a "lending institution," which is a bank, savings bank, savings and loan association, trust company, credit union of which purchaser is a member, insurance company or government entity. If the borrower is applying for a loan through a mortgage broker, it is imperative that the purchaser's attorney modify the contract to contain this revision.
The major concern for the seller is that he or she enters into a contract to sell an apartment and, after four to six weeks, the purchaser is unable to secure a loan, the contract is canceled and the down payment is returned. Accordingly, prior to accepting an offer from an individual to purchase the apartment, the seller should he sure that the purchaser has the financial ability to conclude the transaction and to obtain a loan. The seller's real estate broker should confirm the purchaser's financial status and the purchaser's ability to obtain a loan and pay for the associated closing costs. (One can assume that a realtor would not present a purchaser who is not financially qualified to conclude the transaction). However, if there is no real estate broker involved, it is incumbent upon the seller to obtain a financial statement from the purchaser.
Even if the purchaser appears to have a respectable financial statement, the seller should ask to receive a "pre-approval "letter from a lender or mortgage broker. A pre--approval letter merely states that the lender or mortgage broker has pre-qualified the purchaser for a loan in a certain amount. While a pre-approval letter is not a loan commitment letter, which requires a full underwriting review by the lender, the pre-approval letter, which can be obtained in one day, can give the seller some peace of mind with respect to the purchaser's ability to secure a written loan commitment letter. A pre-approval letter does not include a credit report against the purchaser. If the purchaser has a questionable credit history, the loan may be denied even though the purchaser has a substantial income and assets.
Furthermore, if the purchaser must sell another home or apartment, the purchaser's' commitment letter may provide that the purchaser must be under contract to sell or have closed on the sale of their current residence. The purchaser may not be able to conclude the purchase of the apartment because he or she has not sold their current residence. The seller should inquire as to this matter and the seller's attorney should insert a clause in the contract that provides that the contract is not contingent on the sale of any property that the purchaser currently owns.
As a side issue, the seller of a co-op should seriously consider the issues involved in signing a contract to purchase a new home prior to their purchaser obtaining a loan commitment letter or co-op board approval. If the seller of a co-op enters into a contract to purchase a new home and the purchaser of the co-op does not obtain a loan, the seller may be obligated to complete his or her purchase of the new residence or lose the down payment. Customarily, a contract will not contain a provision that gives a purchaser the right to cancel the transaction if they cannot sell their current apartment.
A purchaser who does not have sufficient assets to purchase an apartment will want to obtain a loan from a lender. The purchaser should always arrange to meet with a lender or mortgage broker prior to signing a contract to determine if they will qualify for a loan in the amount that they want to borrow. It will be a waste of time for everyone involved, including the purchaser, if the purchaser does not qualify for a loan alter the contract is negotiated and signed.
Many purchaser's s do not realize that a lender's determination to make a loan will be based on two primary concerns: (1) The purchaser's assets, liabilities, assets, income and credit and (2) the building's financial condition. While many purchasers may have the financial wherewithal to obtain the loan, if the building does not meet with the lender's approval, the loan can be rejected. A purchaser who has not had a lender check the status of a co-op in advance can result in the declination of a loan.
A lender will review the following issues in evaluating whether to finance a loan for the purchase of a co-op apartment:
* How many units are sponsor owned. If the sponsor owns more than 50 percent of the units in the building, the lender may not make a loan);
* How many units are owner occupied;
* Whether the building operates with an annual positive cash flow (i.e. the income the building receives must exceed the operating expenses of the building);
* The size of the apartment (if the apartment is less than 600 square feet, the lender may not make the loan);
* The building must contain a minimum of 10 apartments;
* The lender, has not already financed more than 25 percent of the units in the building;
* The amount of the underlying mortgage on the building cannot exceed a certain percentage allocated to the apartment (known as the "pro-rata share").
Accordingly, it may be wise to determine if a lender has previously made loans in the building or speak with a mortgage broker to determine if there will be any problems in obtaining a loan. If these issues-do exist, it does not mean that the purchaser cannot obtain a loan. It may only mean that the purchaser will not obtain a competitive loan.
The purchase of a co-op presents an additional issue for a purchaser. Every co-op sets limitations on how much a purchaser can borrow (many co-ops allow a purchaser to finance 80 percent of the purchase price, but some co-ops will limit financing to 50 percent and some do not allow any financing). It is mandatory to determine what financing limitations are imposed by a cooperative corporation prior to signing a contract, since it would again be a waste of time to find that the purchaser is intending to borrow more than the building allows.
Because of the aggressive market, many purchasers agree to eliminate the finance contingency clause in the contract to make the deal. When the finance contingency clause is deleted from a condominium or residential home contract, it eliminates any conditions to the transaction (other than the requirement of the seller to deliver unencumbered title to the premises).
Elimination of the finance contingency clause in a co-op contract still leaves one condition that needs to be satisfied: co-op board approval of the transaction.
Many sellers will demand that the purchaser eliminate the finance contingency clause as part of the offer to purchase the apartment. Elimination of the clause does not, prevent the purchaser from obtaining financing. However, if the purchaser cannot secure financing or an alternative to obtaining monies to close, the transaction will most likely not be concluded and the purchaser may jeopardize the down payment.
The deletion of the finance contingency clause in a co-op contract when the purchaser still intends to obtain a loan raises several very important issues. The standard contract provides that the purchaser must submit the co-op application within 10 days after the contract is fully executed. If the purchaser has not secured a commitment letter by the 10th day, it may be impossible to meet the timing requirements in the standard form of contract. The other dilemma is that the contract of sale, on its face, reflects that the purchaser will not be financing the purchase of the apartment. Accordingly, when the purchaser submits-the application to the co-op board with a commitment letter and the contract is not contingent upon financing, the co-op board may require that the contract of sale be amended to reflect the accurate terms of the transaction.
A recent concern of many sellers is whether the premises will appraise at the amount set forth in the contract due to the inflated market. If the contract is contingent upon financing, the purchaser may have the right to terminate the contract and receive the refund of the down payment if the apartment does not appraise at the amount of the sales price. If the apartment appraisal comes in lower than the sales price, the seller can offer to reduce the sales price to that of the appraisal to try to conclude the transaction. If the purchaser and seller agree to lower the sales price, the purchaser will also have to agree to accept a lower loan amount.
However, if the transaction is contingent upon financing and the premises do not appraise out, the purchaser must still proceed with the transaction with the lower loan amount and will not have an opportunity to negotiate the sales price. For example, a purchaser enters into a contract to buy an apartment not contingent upon financing for $200,000. The purchaser, however, needs a loan of $160,000 to conclude the transaction. If the appraisal of the apartment comes in at $180,000, the maximum amount the lender may loan to the purchaser may only be $144,000 (ie. 80 percent of $180,000, assuming the building allows 80 percent financing). If the foregoing example was contingent upon the purchaser obtaining a loan in the amount of $160,000 and the apartment appraises at $180,000, the seller and purchaser must either agree to lower the sale price to $180,000 or the purchaser has the right cancel the transaction (unless, of course, the purchaser agrees to purchase the apartment at $200,000 with a loan of $144,000).
As a note, the Blumberg contract of sale provides that the purchaser must act in good faith when applying for and securing a loan commitment letter. If the purchaser is unsuccessful in securing a loan due to bad faith, the seller may hold the purchaser in default and keep the down payment. Therefore, a purchaser cannot intentionally try to terminate the transaction by falsifying information on the loan application. If indeed the purchaser has been denied a loan, a copy of the loan declination letter as well as the purchaser's loan applications should be submitted to the seller's attorney when terminating the contract and requesting a refund of the down payment.
As outlined above, the purchaser and seller both must be aware of the issues involved with the finance contingency clause in the contract of sale. A failure to understand the issues raised in this article can only result in hard work by both seller's and purchaser's attorneys and the mortgage broker without a concluded transaction.
(Eric P. Gonchar is a partner in the real estate department at Kane Kessler P.C., who represents purchasers, sellers, lenders, co-op corporations and condominium associations.)
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|Publication:||Real Estate Weekly|
|Date:||Feb 9, 2000|
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