When is a Loan Approval not a Loan Approval?

April 9, 2008 at 7:20 pm Leave a comment

In most real estate transactions, the purchase of the property is contingent upon the Buyer getting a loan at terms specified within the contract and within a specified time, often 17 days per the boilerplate language of the standard contract, though many realtors in the current market with its lending challenges are extending that period to 25 or 28 days. Exceptions are when the Buyer is making an all-cash offer or in a hot market where a Buyer may remove contingencies in their offer up front in order to make their offer more attractive.

In the course of the transaction, the Buyer is expected to remove the loan contingency upon getting loan approval. If the Buyer doesn’t remove the loan contingency, the Seller may require the Buyer to cancel the transaction or Buyer and Seller may negotiate an extension of the loan contingency, sometimes accompanied by the release of a portion of the Buyer’s deposit from escrow as a gesture of good faith.

But what constitutes “Approval”? Loan representatives who take an application enter the data from the application into an automated system and receive an automated Approval (or not). So when that approval comes back, the Buyer can remove their loan contingency, right?

Not so fast. After that automated loan approval, the lender’s rep submits the loan package—application, credit report, pay stubs, copies of bank account statements, and all the myriad other bits of paper comprising an application—to the lender’s underwriting department for review. The underwriter orders the appraisal and reviews all the documents. And here’s where some of the fun can begin. The Buyers’ income may be fine but the underwriter may be concerned about the solidity of an applicant’s job history. Or there may be an item on any of all those pieces of paperwork that cause the underwriter concern. The appraisal, especially in the current market, may come in at a value below the purchase price or the lender may even arbitrarily slash an appraisal by 5-10 percent as a hedge against a declining market. An loan application isn’t approved until the underwriter—and, often, the underwriter’s supervisor—signs off on the application. But at that point, we have approval and the Buyer can remove the loan contingency, right?

Not so fast. When an underwriting department approves a loan, it does so with a number of conditions. Many of them are trivial and many are completely transparent to the Buyer or their agent, information to be furnished by the lender’s rep. Other items are things like the lender being provided with copies of the Buyer’s driver’s license. But then there may be more problematic conditions, such as an appraiser being asked to come up with two or three additional properties, either sold or currently on the market, to validate the appraisal. In some cases, an entirely independent second appraisal is called for. Only when all these conditions, called “pre-document conditions,” are met can the Buyer more or less safely remove the loan contingency.

And, actually, the pre-document conditions are not the end of the line. After loan documents have been issued and signed by the Buyer(s), there are additional pre-funding conditions that have to be met prior to the loan funding. These usually are really trivial, and include such things as the lender calling the Buyer’s place of employment to re-confirm employment status before the loan is funded. For what it’s worth, a Buyer client of mine once changed jobs during escrow just before the loan was due to fund; that provided way too much excitement in the process.

The consequences of removing a loan contingency without prudent diligence can put the Buyer’s entire deposit at risk should the loan fail to be funded. The problems, especially with possibilities such as second appraisals, are even more acute into today’s lending environment. The bottom line is, Buyers and their agents need to be very careful about removing loan contingencies.

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Entry filed under: Market Conditions, Santa Monica real estate, Santa Monica realtor, Tips, Uncategorized. Tags: .

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