Buyers will often include a financing condition when drafting an offer to purchase with their realtor. This clause gives them time to arrange for appropriate mortgage financing as well as the right to retract their offer if they are unable to do so. Since almost all property purchases involve some form of related borrowing, it’s not surprising that financing conditions are common. What may surprise you though, is that the vast majority of buyers waive this condition before they have a firm lender commitment in place. In today’s post we’ll explain why this happens, we’ll outline the risks involved, and we’ll offer some guidance on how you can mitigate these risks if you decide to waive your financing condition early.
First the risks. If you waive your financing condition and are unable to complete the purchase transaction, you will forfeit your deposit. Worse still, if the seller can prove that your breach of contract caused them damages over and above the amount of your security deposit, they can sue for additional damages. This might happen because they were counting on your funds to complete a subsequent purchase of a property, or because they were unable to obtain the same selling price when they relisted the property. The main point here is that waiving your financing condition without having a firm lender commitment in place is taking a substantial financial risk, and it is not a decision to be taken lightly.
That said, most buyers do waive this condition before their lender has signed off on all of their required documentation. This might be because the buyer is in competition for a home and must present a clean offer to have any chance of winning the bid process, or more commonly, because it takes more time to meet all of the lender’s conditions than a standard financing waiver allows. In many cases, and depending on your profile, there is minimal risk in waiving financing if you follow some key steps, such as getting pre-approved, accurately disclosing all pertinent information, and partnering with an experienced mortgage planner who can help gauge the likelihood of any issues arising.
While lenders have many conditions that borrowers must satisfy before being given a final approval, the two most complex conditions cover income confirmation and the subject property’s appraised value. In the lending world, the ideal borrower’s income comes from a salaried job that he/she has held for a year or more. But if you work on commission or are self-employed, lenders will use more subjectivity. Commissioned earnings will be based on two or three-year averages and self-employed applicants can be handled any number of ways (with various adjustments and/or rules being applied). If your financing ratios are tight and you need every dollar of your income to qualify, best to have your lender review your income documentation before signing back your financing waiver.
There’s an old adage that “the best indication of the value of your home is the price someone else is willing to pay for it”. While that’s true, lenders like to get a second opinion by using either a third-party automated valuation report or by requesting a full appraisal. If the lender uses an automated report then the value is returned in a matter of days and any issues can be quickly identified. But if the lender requests a full appraisal, a licensed appraiser is required. Booking the appointment can take a week and generating the comprehensive appraisal report can easily add another three days post-visit. Consequently, appraisal conditions are often not satisfied before financing conditions are waived.
If you are making a substantial down payment on your property, then the appraisal condition presents only the limited risk that you may be required to pay for high-ratio loan insurance if the value is adjusted downwards. (There is also always the very remote risk that the lender will reject the property outright.) The risk in waiving your financing condition before the lender has signed off on the appraisal increases for borrowers who are making small down payments with limited additional resources, because if a property’s appraised value comes in lower than the purchase price, borrowers must increase their down payment to cover the difference.
The other primary indicators of appraisal risk are location and the overall condition of the property. Appraisers rely heavily on comparable sales in the immediate area when estimating a property’s value. The fewer comparables there are, the more subjective the appraiser’s job becomes, especially if your subject property is remote, or unique for the surrounding area. Alternatively, if the property needs a lot of work, the lender may hold back part of the loan until the borrower confirms that certain repairs have been made and that too will require extra upfront cash. If you have limited ability to come with additional funds, make sure your mortgage planner orders your appraisal as a first priority.
While waiving your financing condition before having a fully qualified commitment from
your lender is a fairly common practice, at least in Ontario, you are taking a significant risk when you do this. Like wearing your seatbelt, the odds say you’ll probably arrive in one piece if you don’t wear one, unless of course you don’t. The best rule of thumb is that the less flexibility a borrower has, the more important it is to work fast after signing the offer to ensure that all lending conditions are met prior to waiving the financing condition. An experienced mortgage planner should work with you to identify any red flags, and if there are any, to help you game plan accordingly.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog (integratedmortgageplanners.com/blog). Email Dave