A Contract Series – Part 3(b) The Arizona REALTORS® Residential Resale Purchase Contract Financing Section – Contingences

 

This is Part 3(b) of a series of articles discussing the major provisions in each of the sections of the Arizona REALTORS® Residential Resale Real Estate Purchase Contract (10/22) (“Contract”).  The Financing Section is addressed in two sub-parts because there are so many issues to address.  The previous articles in this series can be located at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com). 

Loan Contingency (2b)

The buyer’s obligation to complete the sale is contingent upon the buyer obtaining loan approval without Prior to Document (PTD) conditions no later than three days prior to the close of escrow (“COE”) Date for the loan described in the Arizona Association of REALTORS® (“AAR”) Loan Status Update (“LSU”) form or the AAR Pre-Qualification Form, whichever is delivered later.

 

• When the seller receives an offer with a completed AAR Pre-Qualification Form, be aware and discuss with the seller that the buyer may be entitled to change financing programs and the terms of the financing contingency in the Loan Status Update, which must be delivered ten days after Contract acceptance. 

• If the seller’s reason for accepting an offer is the loan program submitted in the Pre-Qualification Form, discuss with the seller the advisability of responding with a counteroffer, for example:  "Buyer agrees not to change from a Conventional loan program" and/or "Buyer agrees not to enter into a down payment assistance loan program."[1]  

 Loan Status Update (2e)

The buyer is obligated to deliver to the seller the LSU with, at a minimum, lines 1-40 completed describing the status of the Buyer’s proposed loan within ten days after Contract acceptance and instruct the lender to provide an updated LSU to the brokers and the seller upon request.

As discussed above, in many cases, the LSU will set forth the terms of the buyer’s loan contingency.

The LSU is also designed to assist both brokers and buyers follow through on the four main parts of the loan process: 

·         Pre-Qualification

·         Documentation

·         Underwriting and Approval

·         Closing

 

• Consider using the LSU as an educational tool for both buyers and sellers. 

 

• The LSU lists all the major steps that must be completed before the buyer obtains loan approval and can close escrow. 

 

• Both the listing agent and the buyer’s agent should review the LSU carefully, provide copies to the clients and request updates as necessary.  

 

• If the updated LSU changes the terms of a completed Pre-Qualification Form submitted with the offer or LSU submitted ten days after Contract acceptance, the change may require the seller’s written approval pursuant to section 2k if the change adversely affects the buyer’s ability to obtain loan approval without conditions, increases the seller’s closing costs, or delays COE.

 

• If the buyer fails to deliver the LSU with, at a minimum, lines 1-40 completed within ten days after Contract acceptance, the seller should deliver a cure notice to the buyer pursuant to section 7a of the Contract.   

 

• If the buyer fails to deliver the LSU within three days after the cure notice, the buyer is in breach of contract and the seller can pursue all remedies.

 

• If the buyer’s lender refuses to complete an LSU, the buyer should complete, at a minimum, lines 1-40 of the LSU on their own.

 

• The failure of the buyer’s lender to complete the LSU is not a potential breach and, therefore, not subject to a Cure Period Notice because the lender is not a party to the Contract.  However, the lender’s refusal to complete an LSU could be a ‘red flag’ of possible financing issues to come. 

 

• It is vitally important to remember that in most transactions the lender will update the condition of credit reports, employment status, and buyer’s funds immediately prior to funding, even though there may not be an official condition or indication that the lender intends to do so. In fact, the lender may update this information several times during the loan approval process.

 

• Advise the buyer that any credit applications, employment changes, or any major expenditures during the loan process may place the loan approval and funding in jeopardy.

Changes (2k)

The buyer is obligated to immediately notify the seller of any changes in the loan program, financing terms, or lender described in the Pre-Qualification Form attached with the offer or the LSU provided within ten days after Contract acceptance.

The buyer is only permitted to make any such changes without the prior written consent of the seller if the changes do not:

1. adversely affect the buyer’s ability to obtain loan approval without conditions,
2. increase the seller’s closing costs, or
3. delay COE.

Appraisal Contingency (2l)

The buyer’s obligation to complete the sale is contingent upon an appraisal of the Premises acceptable to the lender for at least the purchase price. If the Premises fail to appraise for the purchase price in any appraisal required by the lender, the buyer has five days after notice of the appraised value to cancel the Contract and receive a refund of the earnest money or the appraisal contingency shall be waived, unless otherwise prohibited by federal law. 

 

·         If the buyer is applying for a FHA or VA loan, the waiver of the appraisal contingency is prohibited by federal law.  Unlike other types of loans, FHA and VA buyers cannot waive the appraisal contingency. 

 

·         If the appraisal comes in below the purchase price and the buyer can make a strong argument that the appraisal is low, the buyer can request that the lender order a second appraisal.  Otherwise, the seller can lower the purchase price, or the buyer can waive the appraisal contingency, if allowed, and pay the difference between the purchase price and the appraised value (loan amount) at COE.

 

·         If the buyer waives the appraisal contingency and is thereafter unable to close escrow due to the appraisal, the buyer will forfeit their earnest money.

 Although the buyer is instructed to conduct all desired inspections to determine the “value and condition” during the Inspection Period, the appraisal contingency is a separate contingency related solely to financing.

Appraisal Cost(s) (2m)

This section indicates who will pay the initial appraisal fee when required by the lender and if the seller is paying the appraisal fee whether the fee will apply against the seller’s concessions.  The buyer also agrees to pay for any updated lender required appraisal and to pay for any lender/appraiser required inspection costs.

 

Three Days Prior to COE (2b)

No later than three days prior to COE, the buyer must complete one of the following.

         i.            Sign all loan documents.

 

OR

       ii.            Deliver notice of loan approval without PTD conditions and dates of receipt of Closing Disclosures from lender.

 

• PTD conditions are what lenders call all the actions/approvals necessary before the lender orders the closing loan documents and instructions. PTD conditions include items that must be provided and reviewed by the underwriter before the loan documents can be ordered.

 

• This information is important to the seller because it will help the seller understand when the transaction may close escrow. The loan cannot be consummated (i.e. – execution of the promissory note and deed of trust) less than three business days after the Closing Disclosure is received by the buyer.

 

OR

    iii.          iii.   Deliver to seller or escrow company notice of inability to obtain loan approval without PTD conditions. 

 

• To give everyone involved in the transaction notice of an unfulfilled loan contingency, the buyer is obligated to deliver a notice of the inability to obtain loan approval to the seller or the escrow company no later than three days prior to the COE Date.

 

• If the buyer fails to deliver this notice by three days prior to the COE Date, the seller must give the buyer a Cure Period Notice pursuant to section 7a of the Contract and a three-day opportunity to deliver the notice of the unfulfilled contingency.

 

• If the buyer fails to deliver the notice, the buyer is in breach (not for the failure to qualify, but for the failure to deliver the notice) and the seller agrees to accept the earnest money as damages as set forth in section 7b.

Unfulfilled Loan Contingency (2c)

The Contract is cancelled for an unfulfilled contingency and the buyer is entitled to a return of the earnest money if, after a diligent and good faith effort, the buyer is unable to obtain loan approval without PTD conditions and delivers the notice of inability three days prior to the COE Date.

The inability to obtain loan approval three days prior to the COE Date after a diligent and good faith effort is not a potential breach of contract. In other words, the inability to obtain loan approval does not trigger a curable event and therefore, the Cure Period does not apply to extend COE.

 

·         If the loan contingency is not fulfilled, the buyer has no obligation to close escrow. Therefore, the Contract can be considered cancelled, terminated, or unenforceable against the buyer.

 

·         Even though the Contract is no longer enforceable against the buyer, written mutual cancellation instructions should be executed.

 

·         If the parties agree to allow the buyer additional time to obtain the loan, the parties should execute an amendment to the Contract extending COE.

However, the failure to deliver the notice of the inability to obtain loan approval is a potential breach and the seller should issue a cure notice.  If the buyer fails to deliver the notice before expiration of the Cure Period Notice, the seller is entitled to the earnest money.

 

·         Although the buyer’s obligation to close escrow terminates due to the unfulfilled contingency, the seller still has the right to enforce the buyer’s obligation to deliver the notice.

 

·         If the seller believes that the buyer obtained loan approval or that the buyer failed to make a diligent and good faith effort to obtain loan approval, the seller should contest the notice in writing to both the buyer and the escrow/title company.

 

o   If the buyer does not produce evidence of the inability to obtain loan approval after a good faith effort that is satisfactory to the seller, the seller can request that the escrow/title company release the earnest money to the seller.  If the escrow/title company holds the earnest money due to the dispute or releases the earnest money to the buyer, the seller can initiate mediation to resolve the dispute.

 

o   Any such buyer/seller mediation is strictly between the parties and should not involve the agents.  However, if such a dispute does arise, the agents involve in the transaction should notify their broker or manager. 

 

Interest Rate/Necessary Funds (2d)

The buyer agrees that:

 (i)                 the inability to obtain loan approval due to the failure to lock the interest rate and “points” with the lender during the Inspection Period;

OR

 (ii)              the failure to have the down payment or other funds due from the buyer necessary to obtain the loan approval without conditions and close this transaction;

is not an unfulfilled loan contingency.

 

·         The Contract does not require the buyer to lock the interest rate during the Inspection Period, however the failure to lock the interest rate can put the buyer at risk of closing at a higher rate or breaching the Contract. 

 

o   For example, If the buyer’s Pre-Qualification Form or LSU stated an interest rate not to exceed five percent, and the buyer qualified and could have locked at five percent, but failed to do so during the Inspection Period, the buyer is at risk of being obligated to close at a higher rate.  If the buyer can get the other loan terms described in the Pre-Qualification Form or LSU at six percent at COE, the buyer will be obligated to close escrow or will be in breach of contract (after the expiration of the Cure Period).

 

·         If the buyer does not lock but cannot obtain loan approval for a reason other than the interest rate, the Loan Contingency is unfulfilled, and the buyer is entitled to a return of the earnest money.

Conclusion

Although the number of all cash sales have increased in recent years, most residential resale transactions involve financing.  Therefore, it is critical that real estate salespersons understand the loan contingency in the Contract and the loan process.    

 

Next Article – Title and Escrow Section

K. Michelle Lind, Esq. is an attorney who currently serves Of Counsel to the Arizona REALTORS®.  She is also the author of the book - Arizona Real Estate: A Professional's Guide to Law and Practice (3rd Ed.) .

For more real estate related articles, visit Michelle’s Blog at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com)

This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.  3/20/23

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[1] Thank you to Mandy Neat for this suggestion. 

A Contract Series – Part 3(a) The Arizona REALTORS® Residential Resale Purchase Contract Financing Section

 

This is Part 3(a) of a series of articles discussing the major provisions in each of the sections of the Arizona REALTORS® Residential Resale Real Estate Purchase Contract (10/22) (“Contract”).  The Financing Section is addressed in two sub-parts because there are so many issues to address.  The previous articles in this series can be located at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com). 

Financing is often the cornerstone of a real estate transaction and obtaining a loan can be a complicated process. A lender generally has no contractual agreement, agency relationship or fiduciary duty to the buyer. Therefore, it is essential for the agents in the transaction to be active in the buyer’s loan process and to follow up with both the buyer and the lender to ensure that the loan approval process is completed by the close of escrow.

The Financing Section of the Contract obligates the buyer to take specific steps to obtain a loan and sets forth the financing contingency.  If the transaction is an all-cash sale, the terms of the Financing Section do not apply to the transaction. 

 FINANCING SECTION

 Pre-Qualification (2a)

The buyer is required to attach an Arizona Association of REALTORS® (“AAR”) Pre-Qualification Form to the Contract offer, which is incorporated into the Contract. The listing agent should review the Pre-Qualification Form very carefully with the seller because it sets forth the terms of the loan contingency if the buyer has consulted with a lender and completed the form.

 ·         If the Pre-Qualification Form is not fully completed or the buyer changes the financing terms in the Loan Status Update (“LSU”) delivered ten days after Contract acceptance, the LSU will set forth the terms of the loan contingency.   This issue will be discussed in the next financing article.

 In reviewing the Pre-Qualification Form:

 ·         If the buyer has not yet consulted with a lender, the buyer should indicate on line three of the Pre-Qualification Form that “Buyer HAS NOT consulted with a lender.” The buyer should then print their name on line four and sign and date on line five. If the box on line three is marked, the buyer does not complete lines six through 42 of the Pre-Qualification Form.

 o   Obviously, if the buyer has not consulted with a lender before submitting an offer, the risks and implications should be discussed with the seller before the seller decides whether to accept the buyer’s offer. 

 ·         If the buyer has consulted with a lender, the buyer should complete the remainder of the form, and indicate the following information. 

 o    Martial status – if a married buyer is purchasing the property without their spouse, there will be specific title requirements that may impact the buyer’s ability to close a transaction.

 §  Discuss these risks with the seller and consider addressing the risks in a counteroffer, for example, requiring an executed disclaimer deed within a certain time frame.  See the Additional Clause Addendum.

 

o   Whether the buyer is relying on the sale or lease of a property to qualify for the loan. 

 

§  If so, consider whether the Buyer Contingency Addendum should be executed or what additional information the seller should be given before accepting the offer. 

 

o   Whether the buyer is relying on seller concessions or down payment assistance to qualify for the loan. 

 

§  If so, determine whether the seller concessions are addressed in the offer or what additional information the seller should be given before accepting the offer. 

 o   The type of loan – Conventional, FHA, VA, USDA or other type of loan.

 §  The type of loan will affect the lender’s requirements and underwriting.  

 o   Whether this will be a Primary, Secondary or Non-Owner Occupied property loan.

 §  The intended use of the property will affect the interest rates available, and the requirements needed for the buyer to qualify for a loan. Primary residence loans can be easier to qualify for and generally offer the lowest interest rates.  

 o   Where the buyer is in the loan process – whether the lender has provided the buyer with the required HUD form for FHA loans, discussed income, assets and debts with the buyer and obtained a Tri-Merged Residential Credit Report. 

 §  Obviously, if the lender has not discussed the buyer’s financial status or obtained a credit report, the lender’s pre-qualification is subject to a great deal of information.

o   Based upon the information provided, the amount the buyer can pre-qualify for, assuming a specified total monthly payment. Based upon the information provided, the amount the buyer can pre-qualify for, assuming a specified total monthly payment. 

 §  The loan amount that a buyer can qualify for is based not only on a monthly principal-and-interest loan payment but on a total monthly housing payment, which includes property taxes, homeowner’s insurance, HOA fees and flood insurance costs. 

 

o   The maximum interest rate and whether it is fixed, adjustable or has a Pre-Payment Penalty. 

 

§  The interest rate “not to exceed” should be reasonable given current market conditions.  If the buyer cannot obtain a loan at or below the stated interest rate, the buyer’s loan contingency could be unfulfilled (unless waived by the buyer) resulting in a cancelled Contract. 

 

§  If the “not to exceed” interest rate was available and buyer failed to lock the rate during the Inspection Period, the buyer is obligated to close escrow at the higher rate assuming that the buyer can otherwise qualify for the loan.  The failure to obtain loan approval due to the failure to lock the interest rate and points during the Inspection Period is not an unfulfilled loan contingency. 

o   The documentation that the lender has received from the buyer.

 

§  Again, the more documentation that the lender has received from the buyer, the more reliable the pre-qualification. 

 o   An instruction for the lender to provide loan status updates to the seller and broker(s) within ten days of Contract acceptance and upon request thereafter.

 o   The name, license, and NMLS (“National Mortgage Licensing System") number of the lender.  The lender’s license number will indicate whether the entity is a banker or a broker.

 §  A mortgage banker is a lending institution that offers a variety of loans, funded with the bank’s assets or by use of a credit line issued in the bank’s name.

§  A mortgage broker generally is an intermediary who brings borrowers and lenders together but does not use its own money to fund the loan.

There is an expiration date on the Pre-Qualification Form because a pre-qualification generally expires when the credit report expires – typically within 60 days.

 Type of Financing (2h)

The type of financing is indicated in this Section: Conventional, FHA, VA, Assumption or Seller Carryback.

 ·         Conventional Loans:  A conventional loan is not guaranteed or insured by any government agency. Conventional loans are usually more difficult to qualify for due to requirements such as down payment, credit score, and income. Conventional loans can be conforming or non-conforming.

 o   Conforming loans comply with guidelines set forth by Fannie Mae or Freddie Mac.

o Non-conforming loans, usually provided by portfolio lenders, have guidelines that are set by the lender underwriting the loan.  (Portfolio lenders are financial entities that originate the loan and keep the loan in their own portfolio rather than selling it on the secondary market).

 

• FHA Loans:  An FHA loan is insured by the Federal Housing Administration.

•  With an FHA loan, borrowers pay for mortgage insurance which protects the lender from a loss if the borrower defaults on the loan.

 

• FHA loans may be an option for buyers with lower credit scores or not much money for a down payment.  And closing costs may be rolled into the loan.

 

• FHA buyers cannot be required to waive the appraisal contingency and FHA appraisers follow HUD guidelines for minimum property standards. 

 ·         VA Loans:  A VA loan may be an option for active military, veterans, or surviving spouses.   The Department of Veteran Affairs (VA) guarantees loans made by qualified lenders.

 o   These loans have lower credit score requirements, do not require a down payment, have lower interest rates, and do not require private mortgage insurance (PMI).

 o   There are some costs the VA buyer may not be allowed to pay with a VA loan, therefore consider requesting that the seller cover some of those costs when submitting a Contract offer.

o   VA buyers cannot be required to waive the appraisal contingency and VA appraisers follow the VA’s minimum property requirements. 

• USDA Loans:  The U.S. Department of Agriculture (USDA) Guaranteed Loan Program assists approved lenders in providing loans to low- and moderate-income buyers in eligible rural areas.

 o   Applicants must meet income eligibility (not to exceed 115% of median household income); occupy the property as their primary residence; and be a U.S. citizen, non-citizen national or Qualified Alien.

 o   These loans may have a lower interest rate, do not require a down payment, and may have a lower PMI, which may be rolled into the loan amount.

 o   The USDA has specific site and appraisal requirements.

•  Loan Assumption:   A loan assumption is when the buyer takes over the seller’s loan and continues to make payments on it. Most conventional loans cannot be assumed because lenders do not allow it with a due on sale clause. However, FHA, VA, and USDA loans may be assumable. 
•  Generally, to assume a loan, the buyer will need to qualify for the loan and will probably incur loan transfer and assumption fees. 

 

• Additionally, the buyer will most likely have to pay cash (or execute a seller carryback) to the seller for seller’s equity in the property.

 

• In agreeing to a loan assumption, the seller should ensure they are released from any future liability on the loan. 

 

• The Arizona REALTORS® provides a Loan-Assumption-Addendum that addresses these and other issues.

 

• Seller Carryback Financing:  Seller carryback financing occurs when all or a portion of the purchase price is financed by the seller.

 

• The Arizona REALTORS® provides Dodd Frank Seller Financing Addendums which should be used in a transaction with seller carryback financing.   

 

• Generally, the buyer will execute a promissory note and deed of trust in favor of the seller, which will be recorded, at close of escrow.

 Loan Application (2f)

Unless previously completed, within three days after Contract acceptance, Buyer is obligated to:

 

• provide lender with Buyer’s name, income, social security number, premises address, estimate of value of the premises (typically the purchase price) and mortgage loan amount sought; and

 

• grant lender permission to access buyer’s Trimerged Residential Credit Report.

Loan Processing During Escrow (2g)

• The buyer agrees within 10 days after receipt of the Loan Estimate to:

            ·   provide lender with notice of intent to proceed with the loan transaction in a manner                              satisfactory to lender, and 

• provide lender with all signed disclosures and documentation listed in the LSU at lines 32-35.

 The buyer agrees to diligently work to obtain the loan and promptly provide the lender with all additional documentation required.

 Loan Costs (2i)

All costs of obtaining the loan shall be paid by the Buyer, unless otherwise provided for in the Contract. 

 Seller Concessions (if any) (2j)

In addition to the other costs the seller has agreed to pay in the Contract, the seller agrees to pay up to a specified percentage of the purchase price or a specified dollar amount for any buyer fee, cost, charge, or expenditure to the extent allowed by buyer’s lender. 

 

·         In some instances, the lender may require that certain expenses be prepaid as a condition of the loan, such as interest or insurance premiums and these “pre-paids” may also be paid from the seller concessions. 

 Conclusion

By staying active in the buyer’s loan approval process and communicating with the lender, the agents should have a good idea prior to the close of escrow date whether the buyer will obtain loan approval and be able to close escrow as agreed. A good lender will communicate to the buyer and the agents, facilitate the loan approval process, and with the help of all parties, be able to fund the loan by the close of escrow date.

 Next Article – Financing Section Contingencies

 K. Michelle Lind, Esq. is an attorney who currently serves Of Counsel to the Arizona REALTORS®.  She is also the author of the book - Arizona Real Estate: A Professional's Guide to Law and Practice (3rd Ed.) . 

 For more real estate related articles, visit Michelle’s Blog at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com)

 This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.  3/13/23