Mortgages: Buyer Contingency Clauses
By John Tax
Because the majority of 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.
For more information, please contact our Real Estate and Construction Group at 440-449-6800.
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