QI think we are in trouble. Three weeks ago, we signed a contract to buy a single-family house. Our real estate broker told us that there was a lot of interest in the property and that if we really wanted to buy we should not put any contingencies into our contract offer. We thought that we could qualify for a mortgage, and took the broker's advice. It now turns out that our credit score is too low and our mortgage lender has turned us down.
We put up a $20,000 earnest-money deposit, and are now concerned that we may lose this money -- as well as the house -- if we are unable to get a loan.
Are we in trouble?
AYes, you may be in serious trouble if you cannot salvage the deal.
There are two important buyer provisions that should be contained in every real estate contract: a financing contingency and a home-inspection contingency.
It's common for anxious buyers to drop those contingencies, often at the urging of real estate agents. But doing so is risky, as you have found out.
A contingency is defined as a stated event that must occur before a real estate contract is binding. Let's look at those two contingencies:
* Financing. For example, you are buying a house for $300,000, and plan to get an 80 percent loan. That means that you have to make up the difference ($60,000) with your own cash, in addition to the various closing and lender charges due at settlement. The monthly principal and interest payment for a $240,000 mortgage, based on a 6 percent rate, amortized over 30 years, will be $1,439. You also will have to pay real estate taxes and insurance, which could cost you $300 or $400 more a month.
Mortgage lenders have formulas to determine whether a potential buyer qualifies for a loan. Obviously, a lender does not want to lend money to someone who cannot afford the monthly payments. Legitimate mortgage lenders do not want to foreclose on your house; they want you to be successful with your purchase.
You should have talked to a mortgage lender before you signed the contract to determine whether you could qualify for a loan. Most lenders will give you a preliminary, or comfort, letter, which states that subject to an accurate appraisal of the property, based on the financial information you have provided the lender, you can qualify for a loan up to a certain amount.
In some cases, that is a pre-qualification letter, for which a lender has reviewed your finances and decided approximately what you would be eligible to borrow. Essentially, it's a preliminary assessment. In other cases, it's a more reliable preapproval letter, in which the lender has run your information through an underwriting system to determine whether you're likely to qualify. Sellers prefer pre-approval letters because they're a better indication that a deal is likely to go through.
You should never give that comfort letter to a seller until after you sign the contract. Why not? If, for example, you are negotiating the sale price, and the seller learns from the comfort letter that you can qualify for a higher purchase price than you are offering, the seller may not be inclined to negotiate the sales price down.
But the comfort letter should be in your hands so you know about how much money you can borrow.
Your sales contract should contain a provision that the contract is contingent -- for a period of days, usually 20 to 30 -- upon your ability to get financing. During the contingency period, your lender will appraise the property and evaluate your credit. If you qualify, you will get a loan commitment letter. If you do not qualify, the lender is required by law to give you a rejection letter. That rejection letter must be given to the seller (or the seller's agent) before the contingency period ends. If the deadlines are not met, you will have to purchase the property or, possibly, forfeit your earnest-money deposit.
* Home inspection. Are you a structural engineer? Do you have experience with home construction? If not, you should include a contingency that gives you a period of time (usually seven to 10 days) after the contract is signed to have the house inspected. If you are dissatisfied with the inspection report, and you advise the seller within the contingency period, you can either terminate the contract and get your deposit back or negotiate credits with the seller to compensate you for the deficiencies you will have to correct at your expense.
Now, let's look at your specific situation. Your contract did not contain a financing contingency and you cannot get a loan. Under the standard real estate contract, you stand to lose your deposit.
However, you should immediately explain the situation to your seller. I would talk directly to the seller, rather than have the real estate brokers talking to each other. It may very well be that the seller has other offers (indeed some that may be higher than your contract price), in which case the seller may release you from the contract and return your deposit.
If the seller is uncooperative, here are some other suggestions about other ways to rescue the deal:
* Ask your lender to reconsider. Lenders are willing to take greater risks for higher interest rates. Depending on the rate, you probably will be better off paying a little more money every month for your mortgage rather than lose your deposit.
* Look immediately for other mortgage lenders. Lenders have many mortgage programs, and perhaps one of them would meet your needs.
* Determine whether you have any friends or relatives who would be willing to either co-sign the loan or at least guarantee payment should you be in default.
* Finally, consult your lawyer. There may be some technical glitches in the sales contract that would give you the right to claim that the contract is invalid and that you should get your deposit back.
I don't care what real estate brokers tell potential buyers. If you don't include those two contingencies in your sales contract, you may be faced with a serious loss of money.
Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address.