But I’m pre-qualified!
Some buyers don’t understand why, when they are submitting a bona fide pre-qualification or pre-approval from a mortgage company, sellers still seem gun-shy. The buyers may feel that if the lender has agreed to lend to them, there’s nothing for the seller to worry about. It’s a bit more complicated than that. First, it’s vital to realize that whatever the lender offers as a pre-qualification or a pre-approval is based on a surface-level conversation or questionnaire. The lender does a much more in-depth investigation of your finances only after you are under contract to purchase a house. As a result, even if you’ve been pre-approved, down the road, the lender could deny the loan–and most sellers know this is a possibility, or are made aware of it by their agents.
Mortgage-contingent offers provide “outs” for the buyer
If your offer is contingent on a mortage, your offer will have a check mark in the “contingent on obtaining mortgage financing” box. While, above, I explained that, even with a pre-qualification/approval, you might still end up being denied, there are a couple of other “outs” that the mortgage contingency paragraph provides for the buyer’s protection. For example, there is a blank line where the buyer agent fills in the interest rate cap. This number represents the highest rate the buyer is agreeing to pay without additonal negotiation. For example, if the interest rate cap is 6.5%, it means that, if the best rate the buyer can get by settlement is 6.75%, the buyer can terminate and have all deposit monies returned. (A buyer with a mortgage contingency who is trying to appease the seller might put a very high number in as a cap or even leave it blank, meaning that, regardless of the rate available at closing, the buyer wouldn’t be entitled to return of deposit monies if she terminated due to a high interest rate.)
Probably the most concerning loophole that the mortgage contingency paragraph creates for the seller has to do with the appraisal. The boiler plate language is designed, if filled in properly, to protect the buyer from having to complete the transaction in the event of a low appraisal (meaning below the purchase price agreed to in the contract). Why? because if the buyer is expecting, for example, an $800,000 loan on a $1,000,000 purchase (an 80% loan), but the appraisal comes in below $1,000,000, the bank now would only be required to lend them 80% of whatever the appraised value is (even if it’s lower by a dollar). So that buyer needs to figure out how to bridge the gap to find that extra money. (Buyers may choose to fill out this section in a way that will completely or partially mitigate this appraisal issue for the seller (for more on appraisal gap coverage, read here).
With prices often exceeding list price, the risk of a property not appraising at purchase price grows the higher the offer. So the possibility of a low appraisal is very real to sellers in today’s market. With lots of competition, most sellers would rather take a slightly lower offer that is not contingent on an appraisal than a higher one that is (or has limited appraisal gap coverage).
To boil it down
With a mortgage-contingent offer, while the buyer can choose to eliminate the interest rate gap and even any possible appraisal gap, it remains contingent on the lender approving a mortgage. Additionally, some people may still cap the interest rate, even if it’s higher than they think rates may go, and most offer a certain amount of appraisal gap coverage as opposed to waiving the appraisal altogether. With a cash offer, there is no appraisal at all. So when the seller receives a cash offer, she knows that the purchase price agreed upon is not going to change due to a low appraisal. Finally, just sorting through the mortgage contingency paragraph to understand exactly what the buyer is or is not offering can be stressful. A non-contingent offer is much more straightforward and loophole-free. It may be a little clearer now why sellers so strongly prefer non-contingent offers to those contingent on mortgage financing.
If you are relocating to the Philadelphia/Main Line area, please go to my blog page and search for posts using the relocation tag. Contact me to discuss your Philadelphia area relocation! jen@jenniferlebow.com/610 308-5973
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