Mortgages: Buyer Contingency Clauses
Because the majority of real estate buyers are not prepared to pay all cash for a property, a contract of sale frequently includes a mortgage contingency clause that permits the buyer to cancel the contract if a mortgage commitment is not obtained within a designated time period. Upon obtaining the mortgage, the buyer no longer has the right to terminate the contract because of lack of funds. However, risks still exist for the buyer.
Merely obtaining a mortgage commitment does not guarantee the lender will make the loan and advance the funds at closing. The lender may refuse to make the loan even though the buyer is not at fault. For example, the standard mortgage commitment gives the lender the right to withdraw if there has been a "material adverse change" in the financial condition of the borrower or in the security to be given for the loan, such as a change resulting from a fire or other casualty. In addition, some lenders may issue commitments conditioned on the receipt of satisfactory appraisals and flood-zone certificates or approval of existing leases or other matters that are within the discretion of the lender.
Fire and Other
Casualties
The most common commitment conditions
relate to fires or other casualties. While the
effect of such a casualty on the sale itself
is likely to be covered in the contract, it
usually is not mentioned in the context of the
mortgage-contingency clause. Consequently,
if the damage cannot be repaired before
closing, the lender may elect not to fund the
loan, leaving the buyer without financing.
One solution is to provide that the buyer may
terminate the contract if a casualty results
in damages that exceed an agreed threshold
amount.
Protecting the Buyer
The best way to protect the buyer from
the risk of commitment contingencies is to
provide in the contract that the buyer can
terminate the agreement without penalty if the lender does not actually make the loan
(unless the cause is the buyer's default under
the loan commitment). However, the seller
may argue that he or she is entitled to some
compensation for holding the property off
the market during the contract period. One
possible solution is for the seller keep the
interest earned on the down payment or be
paid a small amount equivalent to the fee
that would have been charged if the buyer
had been given an option to purchase. On the
other hand, the seller should not be entitled
to any payment if the reason for failure to
fund the loan is due to the seller's inability
or unwillingness to comply with reasonable
requests of the lender.
Real Estate Focus is provided by Somerset’s Real Estate Team for our clients and other interested persons upon request. Since technical information is presented in generalized fashion, no final conclusion on these topics should be made without further review. For additional information on the issues discussed, please contact Michael Fritton, CPA. Whether you are a building owner, building manager, real estate developer, real estate professional or an investor, we hope to provide you with timely information so you may be proactive in making your business decisions.
This article was written by and published herein with the permission from professionals of BDO Seidman, LLP. John Tax is a director in the Real Estate and Hospitality practice in BDO’s New York office. Somerset is a member of the BDO Seidman Alliance, a nationwide association of independently owned accounting and consulting firms.
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