Buyers should take full advantage of the mortgage contingency clause
In my last post, I discussed how a seller can minimize the risk that a buyer will use the mortgage contingency clause in a real estate contract to walk away from the deal.
The contingency places nearly all of the risk for the buyer’s inability to find a home loan on the seller.
This is great for buyers who do not want to get stuck in a real estate contract. The contingency can also be useful to buyers in other ways.
A real estate contract is binding on the buyer and seller from the moment signed, and is one of the classic examples in the law where a court can order “specific performance.”
In other words, if the buyer or seller breaches the contract, the other party can seek to have the breaching party forced to complete the transaction.
This is different than in most contract cases where the injured party can only ask the other party for money damages.
Since it is less likely that a seller would suddenly become unwilling, the buyer bears the greater risk that he or she will want or need to get out of the deal.
The contingency allows the buyer to get out with his earnest money and without the risk that the seller will sue for specific performance.
The buyer can act in good faith, fail to get a home loan and get out of the deal with timely notice to the seller. To protect the buyer, the contingency should:
- Set the interest rate exactly at market to allow the buyer to get out if the interest rate is not favorable.
- Provide that the loan-to-value should be as high as possible to assure the buyer a choice as to the best loan product.
- Make the expiration of the contingency very close to the closing date to provide the ability to exit as late as possible.
The buyer may also be able to use the contingency in bad faith if the buyer massages the situation to make it look like he was unable to get a loan.
Although the seller may have the right to try to obtain a loan for the buyer, the likelihood of that happening is remote.
The major risk for the buyer in this situation is that if the seller thinks the buyer is playing games, the seller could refuse to release the escrow funds.
Of course, losing some small amount of escrow funds is a much better prospect that being forced to purchase a home the buyer no longer wants.
Clint Costa is an attorney and CPA at the law firm of Shaheen, Novoselsky, Staat & Filipowski in Chicago.