"Guaranteed" Pre-Approval Letters

Porous Guaranty; or, "But, Can You Take it to the Bank?"

I feel the same way about "guaranteed" Pre-Approval Letters that I do about "guaranteed" pizza delivery or promises of "on-time" service calls by my cable company:

a) Officially dubious; and

b) Reminded of the reason companies (often) need to offer such promises in the first place, i.e., reputations for lacklustre and/or tardy service.

Standing Out From the Crowd

Which isn't to say that I don't understand what the lender is trying to accomplish.

Standard Pre-Approval Letters are widely understood to signify practically nothing.

In theory, they tell a Seller that the Buyer can afford to buy their home.

In practice, they commit the issuing lender to nothing, and are dispensed after obtaining the most basic information from the would-be borrower/home buyer.

Solving the Wrong Problem(s)

By contrast, as marketed by at least one local lender, a "Guaranteed Approval" loudly promises to pay the Seller an eye-catching amount -- $10,000 seems to be most common -- if the Lender fails to close the Buyer's loan.

The underlying message is clear: 'unlike the perfunctory financial screening performed by other lenders, we carefully qualify our Buyers.'

There are just two catches:

One. All the conditions -- in fine print, naturally -- that invalidate the guaranty, including "if the property is deemed to be in a declining market or if the investor guidelines change prior to closing"; and

Two. The Buyer's financial wherewithal (or lack thereof) isn't what's causing deals to tank these days.

Rather, the biggest obstacles to deals now seem to be unrealistic offering (and asking) prices, followed by low appraisals.

In the first case, the Buyer and Seller never come to agreement on price.

In the second case, the Guaranteed Approval is moot, because the terms contained in the standard Financing Contingency allow the Buyer to walk.

Ultimately, the best way to regard a Guaranteed Approval is like chicken soup: 'can't hurt, might help.'

"Negotiating Least"

"Brittle" vs. "Supple" Deals

He who negotiates least, negotiates best.

--saying

OK, so that's not how it goes (the original version substituted "government" and "governing").

But it's still accurate.

There are 3 reasons why that's so, at least that I can think of.

One. While some people actually like to negotiate -- Realtors often do, for one -- for most people, negotiating is stressful.

As the number of rounds of negotiating climbs, stress rises, conflict increases --and the chance of a good outcome slide.

Two. Related to that, while the two sides' stress is rising, their negotiating positions often harden.

That's in contrast to brief(er) negotiations, when positions are more fluid and ground is easier to close.

Three. Real estate deals these days involve more rounds.

First, there's getting to terms regarding the main Purchase Agreement.

Then, there's the Inspection Contingency.

Then, there's the Financing Contingency, which itself is much more protracted these days -- mainly because of stricter appraisal rules.

When the Buyer and Seller have exhausted each other and it's not even the second inning yet . . . the chances of getting a consummated deal ("a complete game," to continue the metaphor) aren't great.

Real Estate's "Quiet Period" (You Hope)

"No News is Good News"

In an initial public offering ("IPO"), the interval between when a company files its paperwork with the SEC and the SEC approves it, is known as a "quiet period."

What's the equivalent in residential real estate?

The interval between when the lender's appraiser submits their report, and the lender completes their underwriting process (typically evidenced by something called a "written statement").

Domino Effect

No news on this front is decidedly good news; a phone call from the lender to the Buyer's agent regarding the appraisal can only mean one thing: the appraiser is having trouble establishing the home's value.

That means that the lender doesn't have sufficient collateral, which can cause it to reject the Buyer's loan, which can cause the Buyer's Financing Contingency to fail (alternatively, the parties can renegotiate the purchase price).

As I said, no news is good news!

Appraisals & Upper Bracket Homes

Risk of Not Appraising Borne by Buyer

The very rich are different from you and me.

--F. Scott Fitzgerald

Fitzgerald might have added, "and so are their home transactions."

One of the features of truly upper bracket homes is that the individuals who buy them -- by definition -- are people of substantial means.

If they need a mortgage at all, it's often for a relatively small percentage of the purchase price (in lender parlance, their "loan-to-value" ratio is low).

So far, so good.

The downside of pouring so much equity into a home is that the Buyer may not have an out if the home doesn't appraise.

Primer on Financing Contingencies

That's because a bank that has a $3 million dollar home as collateral securing a $1.5 million loan (loan-to-value = 50%) doesn't really care if the home actually appraises for $2.9M; they're still amply secured.

But the Buyer may care a lot!

Normally, when an appraisal comes in low, the bank won't make the loan, and the Buyer's Financing Contingency fails.

Voila! The Buyer can get out of the deal.

Now go back to the hypothetical above.

The loan appraisal comes in low . . . but the bank doesn't care.

So, the Buyer in such a circumstance loses their "out."

To protect themselves, more upper bracket Buyers are inserting language into the Purchase Agreement specifying that the deal is "contingent on the home appraising" for the negotiated sale price.

Confused by Contingencies

Contingencies: 'Small c' or 'Capital C?'

One of the most confusing things about residential real estate -- and there are plenty -- is exactly what it means for an offer to be "contingent."

As Realtors use the term, a "Contingent" offer is one that's contingent upon the would-be Buyer selling their current home, which is what Realtors call "the backup home."

So when is a Contingent offer no longer contingent?

It's not what you might guess, i.e., when the Seller's home has closed and the Seller has been paid.

Rather, by convention, it's much earlier -- namely, when the Buyer's Inspection Contingency has been removed.

Even though a deal at that point is still far from done -- the Buyer's financing is still tentative, the appraisal hasn't been done, etc. -- the presumption is that the odds are good.

"Small c" Contingencies

Adding to the confusion associated with Contingent offers is all the other contingencies (with a small "c") than can be built into an offer.

In theory, a Purchase Agreement can be made contingent on any event happening (or not).

If the Buyer and Seller wanted to make the Purchase Agreement contingent on the Seller leaving a bottle of champagne in the fridge for them, they could (and at the right price, I'd recommend my Seller do it!).

It's also the case that, from the Lender's perspective, there are always contingencies right up until the time the closing documents are signed.

Like, the Buyer keeps their job, hasn't wrecked their credit (say, by filing for bankruptcy), etc.

In practice, the two big contingencies are the ones involving the Buyer's inspection and financing.

The key to keeping contingencies straight is distinguishing between Contingent and Non-Contingent offers on the one hand, and offers that are subject to various contingencies -- at least other than the Buyer selling their current home -- on the other.

For advanced beginners: how the contingency in Contingent offers is removed.

Foreclosure Headache #7 (and #9, #17, #22, etc.)

Lack of Standardized Contracts
Creates Foreclosure Can of Worms

From a realtor's perspective, representing a Buyer trying to purchase a foreclosure can present an endless can of worms.

For starters, there's the issue of the house's condition. What is it?

Unlike a typical owner-occupied home, there are no disclosures, and the Buyer usually must agree to purchase "as-is." Since no one's home, literally, anything can -- and does -- go wrong. Because foreclosed homes in Minnesota are frequently winterized, one of the first issues to negotiate is how -- and sometimes even if -- the prospective Buyer can test the plumbing, heating, and other major mechanical systems.

A second hurdle is response time. Unlike a typical deal, where a sale negotiation can be consummated in 24-48 hours, with many banks the equivalent timetable is weeks (I've even heard of months, in a few cases).

However, undoubtedly the biggest headache associated with foreclosures is, shall we say, the "variety" of bank-required contracts (suffice to say, there are as many bank-required legal forms circulating as there are bank-owned properties). That lack of standardization not only creates a great deal of uncertainty, but can be time-consuming, and can present novel traps and pitfalls for Buyers (and their realtors) each transaction.

Not Just "Boilerplate"

One of the biggest advances in residential real estate the last few decades, at least in Minnesota, is the adoption of standardized purchase agreements and addenda. While the 20-odd page, single-spaced contract you signed when you purchased your home last year may have said "Edina Realty," "Coldwell Banker Burnet," or "ReMAX," the underlying document is the same in virtually every deal.

As Martha Stewart might say, "that's a good thing."

Unbeknownst to most consumers (and unfortunately, not a few realtors), the standard real estate contract is a dynamic, constantly evolving document.

In fact, each year, the purchase forms undergo a series of tweaks and adjustments to address new market conditions (like the prevalence of short sales now); conform with any new state or federal law; and to refine earlier language that has proved problematic.

That combination of standardization and constant updating greatly streamlines the deal process, by creating conventions for handling the complications and ambiguities that can be part of any transaction.

To pick just one example, consider the Financing Addendum.

The standard Minnesota form balances the Buyer's need for time to firm up their financing with the Seller's need for certainty. The compromise is to set a specific date by which the Buyer's lender is to provide a "Written Statement" to the Seller indicating that the Buyer has secured their financing.

What happens if the Buyer's lender doesn't do that? The Addendum explicitly addresses what happens to the Buyer's earnest money, the effect on the transaction, each party's relative rights, etc.

Custom Contracts

Now throw all that out and start over with the bank's required forms.

How much time is the Buyer allowed to line up their financing? How are they to communicate lender approval? What happens if they can't get it? Under what circumstances does the Seller get to keep the Buyer's earnest money -- and when do they have to give it back?

As they say, "read the fine print." And if the fine print happens to be ambiguous . . . prepare for some friction and (more) delay, at the very least. (As a general proposition, you can assume that banks are inserting/deleting language to increase their rights and limit their liabilities relative to Buyers.)

Similar issues can arise regarding the Inspection timing and the Buyer's ability to back out; the scope of Seller disclosures (usually, just disclaimers); and responsibility for any third-party claims on the property (delinquent taxes, contractor liens, etc.).

After navigating all these issues, and investing a few months of their time, Buyers (and their realtors) are as likely as not to discover that the Buyer's offer has been knocked out by another, higher one.

For all this aggravation, you'd think realtors would get a bonus, right? No way.

Not only is the typical foreclosure steeply discounted from the average market price (about $180,000 now), but the "payout" (the commission offered to the Buyer's realtor) is heavily discounted, too.