As the real estate market begins to heat up, buyers are again being confronted with heightened competition. With competition comes the pressure to forgo conditions when placing an offer on a home. When sellers are receiving multiple offers, buyers are often told that including conditions will make their offer less attractive. However, a condition of financing is an important protection for buyers.
What is a conditional offer?
A conditional offer on a home is one where the buyer’s offer is contingent upon the completion of some other item or task. This other item or task is referred to as the “condition”. The buyer will then have a precise time frame for completion of the condition. If the condition is not satisfied, he offer will be voided. In other words, the condition allows the buyer to back out of the purchase in the event they are not able to satisfy the condition.
One common condition is a condition of financing. A condition of financing (COF) allows the borrower tie to confirm with a lender that they are able to obtain a mortgage. If the borrower is not able to secure mortgage financing before the COF date, the offer is null and void. When the offer is nullified, there is no penalty to the person who placed the offer and the seller carries on attempting to locate another buyer.
Why do sellers like unconditional offers?
Unconditional or “firm” offers, gives the seller confidence that they sale will move forward. If two competing offers are for the same amount, a seller will often prefer the one without conditions. If your offer is without conditions and another offer is slightly higher but with conditions, a seller may even opt for the lower offer in favor of certainty. A firm offer is a done deal. The buyer can move forward with looking for a new hose of their own, knowing exactly how much money they have to spend and when the house will be sold. So, for many sellers, a firm offer means a sigh of relief.
Why do sellers like unconditional offers?
Unconditional or “firm” offers, allow the seller to have some comfort that they sale will move forward. If two competing offers are for the same amount, it makes sense that a seller would prefer the one that is without conditions. In the event that your offer is without conditions and another offer is slightly higher but with conditions, a seller may even opt for the lower offer in favor of certainty. A firm offer is a done deal. The buyer can move forward with looking for a new hose of their own, knowing exactly how much money they have to spend. They can stop showing the house and the need to keep it clean and tidy and stages for showings is over. So, for many sellers, a firm offer means a sigh of relief.
Why are conditions so important for buyers?
A “firm offer” is one that is free of conditions and contractually obligates the buyer to proceed with the purchase, upon acceptance by the seller. A buyer’s inability to proceed with a firm offer, results in the loss of the deposit as well as opens the seller up to a potential lawsuit from the seller. Seller’s can sue the buyers to recoup any losses that are incurred because of the seller’s inability to fulfil the contract. These losses can be significant when you consider that the seller may have, in turn, made an offer on another home based on your offer to purchase theirs.
Including a condition of financing, among other conditions, can allow buyers time to do their due diligence to ensure that they will be able to complete the purchase, as planned. This reduces the risk of financial losses that can result from an unforeseen inability to complete a purchase.
If I have a pre-approval, why would I need a condition of financing?
A pre-approval is a document from a lender indicating the likely mortgage amount a buyer will be approved for. In addition, it provides a guarantee that the lender will honor a certain interest rate for a prescribed period of time. This protects the buyer against future rate increases. A pre-approval is obtained by submitting an application to the lender outlining the borrower’s income, expenses, credit score and the expected expenses relating to the purchase.
The pre-approval process is generally quicker and less detailed than the process of obtaining a full approval. The more detailed application that happens after the offer is made can uncover issues the lender was not aware of. The pre-approval also only looks at the borrower and not the property itself. However, the property is an important factor in the application as. It is possible for the lender to discover something that will affect their willingness to approve a mortgage. In short, a pre-approval is not a guarantee of approval.
Potential Risks
Documents do not support application
In creating an application, it is up to the Mortgage Broker to obtain documents which support the details of the application. The Broker will then calculate all of the numbers in the application based on the information in the documents. This may seem straightforward however guidelines for calculating the numbers in the application can be complicated and varied.
A seasoned Mortgage Broker will collect all required documents from a borrower to make their calculations. The pre-approval application will not, however, provide the lender with the documents used to complete the application. Instead, lender will assume that the pre-approval application is accurate.
Once a buyer has an accepted offer, the application is resubmitted to the lender with the property information. The lender will then take a deep dive into the file. This includes examining every detail of the application against the documents supplied. If the lender finds that they don’t agree with the numbers in the application, lending may not proceed. A condition of financing allows the lender time to review all of the documents and confirm that they satisfy the conditions of their approval.
Appraisal does not support the purchase price
An approval from a lender will also be contingent on the value of home corresponding with the purchase price. The lender agreed to extend a mortgage that equates to a certain percentage of the home’s value, not of whatever you’ve agreed to pay. If the market value of the home is less than the purchase price, the lender may decrease their mortgage amount. This means the buyer would need to come up with a larger down payment.
Often purchasers are not in a position to simply come up with several thousand dollars more to add to their down payment. In this case, a condition of financing would allow the buyer to back out of the purchase without any negative financial ramifications.
Lender does not approve property
A mortgage is a loan that is secured against property. This means that the property acts as collateral for the money that is being lent. If mortgage payments are not being made, the lender can force the sale of the property to recover their money. Because of this, it is important for the lender to feel confident that the home could be sold reasonably quickly. Lenders are not in the business of owning houses. When they need to force a sale, they want it done quickly. This means lenders are very focused on the saleability of a property.
An appraisal or even an MLS listing may identify features that make a property more difficult to sell. In this case, a lender may decide that the property does not provide adequate collateral and either decline the application or reduce the amount they are willing to lend.
The Takeaway
A condition of financing is an important tool for buyers to help limit their risk when buying a property. While market conditions can often leave buyers feeling pressured to make unconditional offers, doing so exposes them to increased risk. Working with an experienced Mortgage Broker to understand your risks as well as understand what alternatives you may have in the event that your planned financing falls through, can help buyers to confidently navigate a competitive real estate market.
