So you’ve been pre-approved or pre-qualified by your mortgage broker and are now hot on the trails of your new home. There’s only one problem: you’re losing out on every offer you place.
You might have been advised by family, friends, or a Realtor that a stronger deal will result in a winning bid. And by stronger that usually means removing conditions on your offer to make it more appealing to the seller. These conditions can include home inspections and financing conditions. I’ll be focusing on the financing condition today
A financing condition is a condition placed on the the offer of a property that typically states that the buyer has a certain amount of time (typically 5-10 business days) to arrange financing acceptable to the buyer. If that financing is not put into place before the expiry of that condition the buyer has the option to walk away from the offer. If financing has been arranged (in the form of a mortgage commitment being issued by the bank, and sometimes the completion of a home inspection…more on that second part in a minute) then the buyer can fulfill the financing condition (by way of a Notice of Fulfillment). Once all conditions that have been placed on the offer are either waived of fulfilled, the offer becomes firm.
Okay so lets back up to why you would put a financing condition on a property to begin with. After all, your mortgage broker or bank approved you, right? Well, not so fast. A pre-approval (or what we like to refer to as a pre-qualification) means that we have reviewed your income, credit and other variables (such as down payment) and have determined that you can afford X amount of mortgage. Should be pretty straight forward now right? Not exactly. The other pillar that banks are looking at when it comes to lending you money is the property. That’s right, the lender is lending you money, but not on a handshake and a promise. They are registering a loan equivalent (or sometimes more in the case of collateral charge mortgages) on your property when you close.
I’ll illustrate with an example. Lets say you are pre-qualified for a mortgage of $520,000. Along with your down payment we calculate that you can afford a home of $650,000. You and your Realtor then hunt for that perfect home and find one that you decide to put an offer down for exactly $650,000 that is accepted by the seller. Approved! Right? Well it’s not that easy. Turns out that home was listed for $499,000 and you went right up to your maximum purchase price. After the bank requests an appraisal it turns out that the determined value is $550,000 – $100,000 lower than what you just offered. This is where you have to be very careful. Remember, the bank will lend on the lesser of the purchase price or appraised value. So in this case, the bank will use the appraisers value of $550,000 to determine the loan amount. For an uninsured purchase (where you are putting 20% or more of a down payment) this changes your maximum loan from $520,000 (80% of $650k) to $440,000 (80% of $550k). Meaning your down payment of $130,000 has to move up to $210,000 in order to make up the difference (80% of $100k difference). That seller still is expecting $650,000 on closing day in their account.
So why exactly do banks do this? Well, suppose down the road you are not able to make your payments and default on your mortgage. The lender will try to recover the mortgage loan by selling the property on the open market to pay off the outstanding balance (and usually some hefty fees are also added to this cost). If they provide you a loan based on the purchase price vs the appraised value they have increased their risk position, and as we know banks like to make money not to lose it. If that house isn’t worth what you paid, they’ll have a hard time recouping the money owed to them.
This is even more apparent with insured mortgages. That is, when a borrower has to obtain mortgage insurance due to putting less than 20% down (they have less skin in the game and a higher loan to value position).
The last few years have been a very aggressive sellers market, there’s no doubt about that. With multiple bidding wars and people being priced out of neighbourhoods it has been leading many buyers to drop all conditions on an offer and often times go in much higher than the asking price. Remember that just like home or life insurance a mortgage condition is there to protect you. It can be a pain to deal with, but you’ll be darn glad to have it if you ever need it.
So what are you to do? Should you waive the financing condition? Well, my recommendation in this market is to work closely with your mortgage broker and Realtor to fully understand the market. Eliminate as much doubt on the property that you can when it comes to value (request a home inspection up front, or review recent sales comparables). Your mortgage broker can also make recommendations based on historical appraised values in your area to help minimize your risk exposure. Sometimes you can eliminate redundant conditions, or remove some if given ample time to fulfill others. I also like to run through worst case scenarios and come up with a plan B and C if my clients are set on going in firm on an offer. This is a strategy that can often work in your favour and ease anxiety and stress and has helped many of my clients. Remember, like anything in life, devising a well thought out plan and being able to quickly execute on it helps when trying to win out on your home