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Failure to fund with a financing contingency in NYC

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  • Failure to fund with a financing contingency in NYC

    The most common contingency you'll see in NYC is the financing contingency, otherwise known as the mortgage contingency. A financing contingent deal is one where the risk of financing is addressed with language permitting the buyer to exit the deal if the mortgage fails. This financing or mortgage contingency continues to become more common in today's NYC real estate market.

    As you can imagine however, many buyers will not accept the risk of losing 5% to 10% of the purchase price if the buyer's financing fails, despite their best efforts otherwise. Remember that the standard contract deposit in NYC is 10% of the contract price, although it can be as little as 5% depending on negotiation.

    Let's talk about how most purchase contracts for residential properties in NYC work and how they allocate the risk of financing falling through. Sellers would most prefer to accept a non-contingent offer where in the contract the buyer is allowed to finance the transaction but the risk of getting that loan is on the buyer. Therefore, getting rejected for a mortgage outright or the bank refusing to ultimately fund the loan will not give the buyer an out under the contract and the buyer will have to pay for the property all cash or risk defaulting under the contract. Buyers who waive the mortgage contingency usually do so because they have enough cash or liquid investments to be able to cover an all cash purchase in case the financing falls through. Remember that an uncured default in a residential purchase and sale contract in the New York metro area and Long Island allows the seller to retain the contract deposit!

    However, most buyers who don't have the spare cash to potentially pay for a home all cash will ask for a mortgage contingency when they submit an offer. This mortgage contingency will move a large portion of the financing risk to the seller's side. With a financing contingency in place, a buyer can promptly apply for a loan after contract signing (or even before if they want to get a head start and are confident of securing a deal with the seller) and if the buyer is denied by the bank, the buyer can exit the contract within a certain time limit after contract execution (usually 30 or 45 days).

    However, if the bank issues a mortgage commitment letter and the property appraises, usually within the same 30 or 45 day period, then the mortgage contingency clause in the contract is usually nullified. Keep in mind that just because you have a loan commitment letter does not mean that the bank will ultimately fund the loan on closing day. There are many outs for the bank in the fine print of the mortgage commitment letter! That means if the bank fails to fund the loan for whatever reason even after issuing a commitment letter within the 30 or 45 day period, the buyer is out of luck and will have to find another lender or means of paying for the property. Otherwise the buyer will default and potentially lose the contract deposit!

    As you can see, this is the key risk for buyers even if they have a financing contingency clause in their purchase contract. This time period between the issuance of a mortgage commitment letter and the issuance of a check on closing day can be only a few weeks if you are buying real property such as a house or a condo. If you are buying a coop in NYC, this time period can stretch for multiple weeks or even months as you'll need to submit the loan commitment letter with your coop board package. After your purchase application is conditionally approved, you'll have to wait for a time slot to be interviewed by the coop board. Once you've been approved by the board will you be able to get a clear to close from your bank.

    During this time period between the issuance of the commitment letter and funding the bank will complete various routine conditional funding requirements stated in the fine print. This may include verifying and receiving copies of the buyer's tax returns, pay stubs, account statements and verification of employment. However, things can go terribly wrong during this period. For example, the lender will likely pull an updated credit report after issuing the commitment letter but before funding. Therefore, if the buyer does something stupid during this period like paying a loan late or even opening up a new credit card account, their credit score may be negatively impacted which will cause the mortgage lender to re-evaluate their decision to loan to you.

    Another risk is that banks will verbally verify that you are still employed usually one or two days before closing. That means they will call your employer (usually at the phone number you provide them) or HR department to verbally verify that you are still duly employed. This can be a huge problem if the buyer gets fired or otherwise loses his or her job after a loan commitment letter has been issued but before closing happens. If the bank finds out that you aren't employed any longer, they will likely cancel the loan unless you have substantial other sources of income or assets.

    So what can you do to mitigate the risk of this funding gap? First, ask your real estate attorney to negotiate a funding contingency for you in the purchase contract which will allow you to exit the contract and get back your contract deposit in the event that your bank fails to fund the loan. This is worth a try even though most sellers will not agree to this because it is non standard.

    Alternatively, you could ask your lawyer to negotiate a more reasonable penalty than your entire contract deposit in the event that you need to exit the contract because of a failure to fund. Perhaps your lawyer can negotiate a fee that is more reflective of the actual damages sustained by the seller, such as losing time on market. While important, time on market is usually not worth 10% of the contract price. Perhaps $10,000 to $20,000 would be a more reasonable amount. Or even $2,000 or $3,000 if you can get away with it and the seller is really desperate!

  • #2
    This is a really scary scenario that can happen more often with new development condo purchases I've been told. Very helpful post, I definitely made sure to check with my lawyer during our process.

    The risk of a job loss is pretty small in the one or two months from contract signing to closing. However, if you are buying new construction that's scheduled to close 2 years from now, then yes that can be a much bigger risk. Who knows if the buyer will lose or be changing jobs over the course of 2 years!

    And yes if the buyer loses his job and experiences reduced income, then the bank can certainly renege on the mortgage commitment letter as one of their outs. It's definitely a risk that more buyers should be aware of. Just because you have a mortgage commitment letter does not mean there's no risk of failure to fund by your bank!

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    • #3
      Originally posted by Benny View Post
      This is a really scary scenario that can happen more often with new development condo purchases I've been told. Very helpful post, I definitely made sure to check with my lawyer during our process.

      The risk of a job loss is pretty small in the one or two months from contract signing to closing. However, if you are buying new construction that's scheduled to close 2 years from now, then yes that can be a much bigger risk. Who knows if the buyer will lose or be changing jobs over the course of 2 years!

      And yes if the buyer loses his job and experiences reduced income, then the bank can certainly renege on the mortgage commitment letter as one of their outs. It's definitely a risk that more buyers should be aware of. Just because you have a mortgage commitment letter does not mean there's no risk of failure to fund by your bank!
      Do you think a developer is really interested in pocketing a buyer's deposit? I'm sure the developer would prefer to help the buyer figure out another way to come up with the money instead of just pocketing a small deposit and then having to find a new buyer?

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