Gambling on Loan Commitments

 

The new financing contingency in the Real Estate Commission-approved contract is §5b and reads as follows: “Loan Commitment. If Buyer is to pay all or part of the Purchase Price by obtaining a new loan as specified in §4b, this contract is conditional upon Buyer obtaining a written loan commitment including, if required, (i) lender verification of employment, (ii) lender approval of Buyer’s credit-worthiness, (iii) lender verification that Buyer has sufficient funds to close, and (iv) specification of any remaining requirements for funding said loan. This condition shall be deemed waived unless Seller receives from Buyer, no later than Loan Commitment Deadline (§2c), written notice ob Buyer’s inability to obtain such loan commitment. If Buyer so notifies Seller, this contract shall terminate. If Buyer waives this condition but does not close, Buyer shall be in default.”

This provision is very much different than the pre-1999 financing contingency (section 4.b.) In the following respects:

  1. In most situations under the new contract, whether the buyer obtains a loan commitment by the deadline is irrelevant. If the buyer obtains a loan commitment and timely informs the seller, then the contract stays in effect. If the buyer does not obtain a loan commitment and the buyer fails to timely inform the seller, then the contract still stays in effect. If the buyer does not obtain a loan commitment and the buyer fails to timely inform the seller, then the contract still stays in effect. Whether the buyer actually obtains a loan commitment only makes a difference in the circumstance where the buyer obtains a loan commitment and then wants to avoid proceeding with the dealMore conventional financing contingencies raise uncertainty about what “loan approval” means. The new contingency avoids much of this debate. Yet buyers should understand that unless they provide the seller “written notice of Buyer’s inability to obtain such loan commitment” by the loan commitment deadline, they are probably stuck in the deal.
  2. Under the new contingency, the burden is on the buyer to determine the reliability of the of the loan commitment. The following may be a common scenario: (a) Buyer obtains a loan commitment. (b) Based upon the commitment, the buyer decides to proceed with the contract. (c) The loan is not funded. If the buyer cannot otherwise come up with the funds to close, the buyer will be in breach. (The warning at the end of §5b reading, “If Buyer waives this condition but does not close, Buyer shall be in default,” may not always be accurate.) The buyer will be in default regardless of whether the failure to fund the loan is the fault of the buyer or someone else. The buyer also seems to be stuck in the contract even after receiving a loan commitment with contingencies that the buyer cannot satisfy.When a buyer does not provide notice of the failure to obtain loan commitment, the buyer is essentially betting that the loan will be funded. If the buyer bets wrong under a liquidated damages contract, then the buyer “only” loses the buyer’s earnest money. Under a specific performance contract, the stakes are higher.Again, the new financing contingency avoids arguments about whether the loan was “approved” or not. It also avoids arguments about whether the failure to fund was the fault of the buyer. Depending upon the amount of the earnest money, whether the contract is liquidated damages or specific performance, the hardship to a seller of a buyer breach, and other factors, the buyer may be making a reasonable bet.

    However, some buyers will lose bets they did not realize they had made. Even informed buyers will look to blame their lenders, the brokers who recommended those lenders, and the same brokers who will be accused of not informing buyers of the workings of §5b. Brokers working with buyers need to give those buyers an opportunity to make an informed choice about the bet.

  3. Sellers have little leverage to dismiss a foolishly brave buyer. Some buyers will make an informed decision to bet their earnest money even though they do not have a loan commitment. The seller is probably stuck with the buyer (and the uncertainty of whether the deal will close) until the closing date. Seller will seek to obtain sufficient earnest money and early closing dates to protect against these buyers.

Conclusion.

In most situations, under prior versions of the contract, the risk that the buyer’s loan was denied was borne by the seller. Now, in many situations, such risk will be borne by the buyer. Sellers can also be hurt by the new language as sellers have no means to force an early termination of a contract against buyers who do not obtain loan commitments by the loan commitment deadline. It is beyond the scope of this article to advise parties on the different strategies for coping with this risk shift. Brokers can take classes and work with their attorneys, buyers, sellers, and lenders to manage the risks in the new paradigm.

 

Jon Goodman is a shareholder with Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm. His practice areas include Real Estate,Brokerage Law, Contracts, Land Use, Leasing, Real Estate Title, Association Law, Business Law, and Finance. Contact Jon Goodman.

Disclaimer — Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.

JONATHAN A. GOODMAN