04/21/2017 : A Prequalification Letter Is Not A Binding Loan Commitment
By Benny L. Kass
April 21, 2017
We are buying our first home, and there is a financing contingency. We had 30 days to get a loan commitment. Immediately after the contract was signed by the sellers, we applied for a mortgage from a large commercial bank. We just received a prequalification letter and submitted it to the seller. The contingency will expire in five days. The seller said this is not a loan commitment. Is he correct and if so, what should we do? — LaKeisha
Unfortunately, your seller is correct. The prequalification letter is not a firm, binding loan commitment. Typically, home buyers contact a lender before finding their dream house so they will have a good idea of how much they can afford. Once you formally make application for a loan, even with the prequalification letter in hand, the lender will most likely require more information, such as bank statements, pay stubs or other documentation proving you can qualify for the loan. According to Brooklyn Law School professor David Reiss, “prequalification is not a binding agreement. It is one of a number of real estate myths that should be understood.”
I suggest you immediately go back to the seller and explain that you thought you had a loan. I would ask for a twoweek extension of the financing contingency. If it is granted — and it must be in writing — explain the situation to your lender and make sure you get a real commitment within that twoweek period.
On the other hand, if the seller will not agree, you have three alternatives. First, walk away from the deal, and advise the seller in writing that you are exercising your rights to cancel pursuant to the financing contingency. If the seller really wants to sell — and there is no one currently looking at the property — the seller may change course and grant the requested extension.
Second, before the fiveday contingency expires, try to persuade your lender to give you a real, positive loan commitment letter.
And third, you can decide to move forward beyond the contingency and hope that the lender will come through before the scheduled closing. This, of course, is risky. If you do not get the loan, you can lose your deposit. In fact, depending on what rights the seller has in the contract, you may also be sued for damages relating to a breach of your contract.
My wife and I are house hunting. A real estate agent friend told us that the market is hot, and there are very few houses available for a large number of potential buyers. We were advised to consider including an escalation clause in any contract we present to a seller. And if there is an escalation clause, how do we deal with the amount of the loan we plan to get. It was also suggested that we decline having a home inspection. What do you think about these issues? — Alvin
Maybe for the first and absolutely no for the second.
Let’s look at the inspection contingency. Unless you are a professional engineer or architect, what do you know about houses? Is the electricity up to code? Does the HVAC system work? Are the joists that seem to be holding up the basement ceiling adequate? You are investing in what may be the biggest purchase of your life; don’t take a chance that something — possibly major — will occur soon after you take title. If a seller is not willing to let you have 10 to 12 days after signing the sales contract to have a professional inspector carefully go over every detail in the property, my advice: Go somewhere else.
I write from experience with some clients who wanted an expensive house but the seller was not willing to allow a brief inspection period. Against my strong advice, they bought the house without the inspection. Four months later, they called to tell me they should have listened to me; they had serious roof damage that cost them almost $100,000 to correct. Fortunately, they could afford it. And there was no insurance coverage either.
What about the escalation clause? Let’s look at this example. In my experience, in most parts of the country, the potential buyer makes an offer, and the seller has three alternatives: accept, reject or counteroffer. You put in an offer of $450,000.
The seller gets another offer with similar terms but with the price of $452,000. Sorry, you lose.
How do you try to protect yourself? You include in the offer a statement that you will pay $1,000 more than the highest offer, subject, however, to a cap of $456,000.
When advised that the other offer is $452,000, your escalation clause bumps the contract price up to $453,000 and you will be the winner. But there are important provisions to be included in your escalation. You want proof there is a real offer at the highest price. I have been involved in a case where an unscrupulous agent indicated — falsely — that there was a higher offer, and my client, without seeing any evidence, increased the offer by $5,000. You should review a copy of the other offer; the name and other personal information of that buyer can be removed.
Incidentally, the agent involved in my case paid my client $5,000 plus my legal fees. So when you are about to sign a real estate contract (or any contract for that matter) try to insert the following language: “The prevailing party in any litigation or arbitration shall be awarded reasonable attorney fees and court cost.”
If you submit the escalation clause, how do you handle the amount of the mortgage loan you plan to get? Typically, your contract offer states you will get a loan of 20 percent — or 10 percent or even 3 percent — of the purchase price. If the original offer is increased, there are three ways to deal with the loan. First, you can pay the difference in cash, and there is no need to change the terms in the contract. Alternatively, you can change the loan amount in the contract to reflect the new price. Or you can partially increase the loan amount and pay the difference in cash.
Bottom line: I am not a fan of escalation clauses, but if this is really your dream house, make sure you include the necessary protections discussed above. And most real estate agents should have a form escalation clause that includes these protections.
I recently bought a condo and was told my purchase price included a parking space in the garage. Now I am told it is a limited common element. What does that mean? — Julian
In a condominium association, there are three distinct elements: (1) common elements — the roof, the elevators, the lobby, (2) the unit — the “box” in which you live and (3) limited common elements (LCE) — items such as a balcony or a patio that is outside of your unit but is not accessible to every unit owner. In other words, they’re limited.
You will find these definitions in the declaration (master deed) for your association.
Read it carefully to make sure your parking space is, in fact, an LCE. I always recommend that condo associations prepare a master list of units assigned to parking spaces, and record that list among the land records where the property is located. If a parking space is reassigned to another unit at a later date, the master list should be amended. That’s the best protection to assure that everyone knows who parks where.
If, in fact, your parking space is a limited common element, use and enjoy it.
Benny L. Kass is a Washington and Maryland lawyer. This column is not legal advice and should not be acted upon without obtaining legal counsel. Send questions to [email protected].