Loan Contingency Review of Common Issues

Questions often come up regarding Loan Contingencies. Here’s a quick review of issues we often see.

Interest Rate as TBD
Inserting TBD into the interest rate section of a loan contingency can make the contract void and unenforceable as too vague and indefinite if it is challenged.  However, completing the section with “current prevailing rate” or “market rate” is generally enforceable.  Similarly, if the loan contingency omits an interest rate altogether, the contract can be held to be unenforceable as too vague and indefinite.  Remember, the entire contract would be unenforceable, not just the loan contingency.

Late Appraisals and Denial Letters
If an appraisal has not been completed prior to the end of the appraisal & finance contingency, the buyer cannot terminate the contract with a loan denial letter, based solely upon the reason "insufficient property data."

Use of Approved Lender and Loan Denial Letter was expanded in the 1/1/2022 printing to include new sections (e) and (f), reasons upon which a loan denial letter may not be solely based:  

(e) the Property not appraising for at least the purchase price unless this Agreement is subject to an appraisal contingency and an appraisal meeting the requirements of this Agreement has been performed; or 
(f) the lender not having completed underwriting the loan request. 

Therefore, an appraisal not being completed is not a valid reason for a denial letter during the finance or appraisal contingency. So, if an appraiser hasn’t met a loan deadline, the buyer cannot use that as a sole basis for a loan denial letter. It is not considered “insufficient property data.”

Use of an Appraisal by a Non-Approved Lender
Where there is an “Approved Lender” included in §2 and the buyer chooses to use a non-approved lender, a buyer can still ask the seller for a price reduction or terminate the contract per the Appraisal Contingency, even if a non-approved lender did the appraisal.  The forms committee intended that a buyer can ask for a reduction based on a low appraisal from an appraiser selected by any Lender, not just an “Approved Lender.” 

However, the buyer loses the ability to use a loan denial letter from a non-approved lender, but the buyer’s right to ask for a reduction in price or termination for a low appraisal stands – even if it is from the non-approved lender’s appraiser.

Notice of Intent to Proceed with Loan Application

in order for a buyer to terminate without penalty (get their earnest money back) based on a loan denial, the buyer must have fulfilled all the requirements in the exhibit.  That includes having promptly sent the Notice of Intent to Proceed with Loan Application. Put another way, if the Notice of Intent to Proceed with Loan Application was not sent to the seller, the seller can legally keep the buyer’s earnest money even when the buyer was legitimately denied a loan and supplied the denial letter to the seller within the allowed time period.


This is the relevant language in the loan contingency:
Buyer to Notify Seller of Intent to Proceed. 
When it is known, Buyer shall promptly notify seller of any mortgage lender to whom Buyer has sent a notice of intent to proceed with loan application and the name and contact information for the loan originator.


Use of Approved Mortgage Lender and Loan Denial Letter. 
Buyer may terminate this Agreement without penalty based upon an inability to obtain the Loan(s) only if Buyer fulfills all of the applicable requirements set forth in this Exhibit.  (at the bottom of the section)


Approved Mortgage Lenders and Pre-Approval Letters
Including the name of an Approved Mortgage Lender and including a pre-approval letter from a lender are NOT substitutes for the notice.  In fact, including the name of an approved lender in the financing contingency may not be to your buyer’s advantage because then a denial letter must come from that particular approved lender.


Add the Notice to Proceed to Your Contract to Close Process
You should add “Send Notice of Intent to Proceed with Loan Application” to your process.  Yes, this is another step, but it is also another way to demonstrate your value to your client by managing the time limits and requirements to make sure clients are protected.


The “Intent to Proceed” is a step in the loan process which takes place between the Borrower and the Lender.  It is not the same thing as the NOTICE of Intent to Proceed with Loan Application that is sent to the seller.  The Buyer’s Agent needs to tell both Buyer and Lender to alert the agent once this is done so the NOTICE can be sent.


Notice Form GAR 816
The general notice form from GAR should be used to send the notice.  The language is simple:
“The Buyer hereby notifies the Seller that Buyer has communicated their Intent to Proceed with Loan Application with (Lender) _______________, Loan Officer, ____________ at (contact information) _____________________.”




Loan Denial Letters
GAR financing contingencies, including Conventional, FHA, VA and USDA-RD, include a very specific, time limited provision regarding Loan Denial Letters. If your buyer is denied a loan and the buyer can legitimately use the denial to terminate and get their earnest money back, don’t forget to timely send the Loan Denial Letter or the earnest money might go to the seller instead.

These are the steps to be taken and the rules to follow.

1. The Buyer must notify the Seller (Seller’s agent) of the loan denial within the contingency time period.  Use the GAR Notice form F816 and ask for a Read Receipt.  
   
2. The Buyer must provide the Seller with a Loan Denial Letter from the lender within seven (7) days from the date of Notice.  It’s ok if the 7 days falls outside of the contingency period, but the notice of denial to the seller must be within the contingency time period.  The reason for the additional 7-day period to produce the Loan Denial Letter is because lenders may not be timely.  It may take days for the lender to produce the letter.  If the lender does not produce the letter within the 7-day period, the finance contingency is completed and the Buyer can lose the earnest money.  In effect, the sale becomes a “no financing” sale and the buyer’s earnest money is at risk if the buyer does not close.
   
3. A Loan Denial Letter must be for the Loan(s) described in the Finance Contingency. If the interest rate in the contingency says Not greater than 5.00% for a 30-year term, getting denied for a 15-year term at 6.00% doesn’t work. A buyer may apply for different loans; however, the denial of other loans may not be a basis for a buyer to terminate.  
   
4. If there was an Approved Lender, the denial letter must be from that Approved Lender.
   
5. A Loan Denial Letter from a non-institutional mortgage lender (private lender) cannot be the basis for Buyer to terminate this Agreement.
   
6. The Loan Denial Letter may not be based solely upon one or more of the following 4 reasons. However, even though one of the 4 reasons may apply, if the buyer has an additional legitimate reason to terminate, such as insufficient income, then the “solely” provision makes the Loan Denial Letter valid and allows the buyer to terminate without penalty.
   

• Buyer lacks sufficient funds other than the amount of the Loan(s) to close; 
  
• Buyer not having leased or sold other real property (unless such a contingency is expressly provided for in this Agreement); 
  
• Buyer not having provided the lender(s) in a timely fashion with all information required by lender, including but not limited to, loan documentation, Official Wood Infestation Reports, structural letters, well tests, septic system certifications, flood plain certifications and any other similar information required by lender (hereinafter collectively “Required Information”); or 
  
• Buyer making purchases that adversely affect Buyer’s debt to income ratio. 
  

August 11, 2023