Loan Contingency Removal (Q+A)

                                                            Q.  Please explain the purpose of a loan contingency removal and how it functions.

A.  Ordinarily, a buyer needs a home loan to purchase real estate. The loan contingency period provides time for the buyer of real property to line up financing, i.e. get approved by a lender.  If he (she or they) cannot qualify or get approved the financing contingency is the buyer's escape clause.  A typical financing contingency is 30 days.  The default period in which to remove the loan contingency period for CAR (California Association of Realtors) is 17 days, unless otherwise stated.  The reason for a specific number of days is that in contract law there is the notion that “Time is of the essence”.  This means that by accepting an offer from a buyer the seller is removing his property from the market, thereby excluding it from consideration and receiving potentially better offers.  Thus, it is the responsibility of the buyer to act in a diligent and timely manner to secure financing so as to not delay the execution of the contract which could be damaging to the interests of the seller.

If the buyer is unable obtain financing within the allotted time he is faced with one of three decisions: cancel the escrow, have his agent negotiate for an extension with regard to securing financing or waive the contingency and hope that he can find financing and close by the end of escrow.  If he elects to proceed with the escrow and is unable to find a lender to approve his loan, his deposit is then forfeit.

Occasionally, even professionals do not understand what a loan contingency is for.  It was not too many months ago that I was dealing with a realtor for whom I already had the buyer pre-approved. You would think that she of all people would understand what a loan contingency is and how it functions since it was her responsibility to negotiate the time frame of this stipulation in the purchase contract.  Nonetheless, even though our client had been pre-approved for the purchase and I had furnished her with a pre-approval letter and a loan commitment letter from the lender she continued to importune me for an “approval” because as she put it she “was looking out for her client’s best interest.”  Even though I iterated and re-iterated that our client was approved, it finally dawned on me that the reason she continued to ask for the approval was because she didn’t understand how a loan contingency functioned.  So, I attempted to tactfully explain to her my understanding of a loan contingency and why I was unable to furnish her with anything more than the commitment letter she already had.  Suddenly, she discovered that she “had everything that she needed.”

Her misunderstanding arose because she did not understand that all pre-approvals are conditional approvals, that is, they are subject to a satisfactory appraisal and the usual proof of income, verification of assets, employment, reserves, etc.  Nor did she understand that from day one she had what she needed.  A full-on approval is granted only when the underwriter has signed off on all the conditions; this is the point at which one goes to docs (signing).  From the outset our borrower was “approved” in the sense of being able to have the loan contingency removed.  As a borrower must be approved, similarly, the property be approved, that is, the subject property must appraise for at least the sales price and to be found to have a clear chain of title.

To preclude confusion, the loan contingency should specifically describe the loan the buyer is seeking.  In essence, the buyer is saying that if I get the loan I describe, my loan contingency will be considered met. The best way to insure this is to get a written copy of the loan approval from the lender before you remove your financing contingency. This approval should state the loan amount you are approved for along with the interest rate and the date by which the transaction must close in order for the interest rate to stay in effect.  The buyer needs to make sure that his pre-approval letter matches these terms.  If the   buyer is already pre-approved for a loan, there is very little chance the transaction will fail to close because of loan approval.  As previously mentioned, if the property fails to appraise at the purchase price, the loan will not receive full approval.  But, other than that, there are few conditions that prevent full loan approval from being given when the buyer has been pre-approved.

There are a few variations on loan contingencies that should be mentioned.  The buyer may require a loan contingency that stays in effect until the close of escrow. It may not be in the best interest of the seller because his property is effectively off the market until the buyer cancels or closes escrow.  But, it may be a necessary condition when buyers are scarce.  Or, the buyer may require a loan appraisal contingency that states that the buyer is already pre-approved for a loan so there is very little chance the transaction will fail to close because of loan approval.  As previously mentioned, if the property fails to appraise at the purchase price, the loan will not be approved. But, other than that, there are few conditions that prevent full loan approval from being given when the buyer has been pre-approved.

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