2 Agent Misunderstandings That Can Ruin Your Transaction
Two of the more common mistakes I see on real estate contracts is
The short answer is, neither of these is allowed by lenders. |
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Allowances / Holdbacks / Credits
The idea is, you’ll buy my house from me, at closing I’ll let the escrow keep $xxxx dollars from me for you to use on repairs to the house.
Just this morning I ran a search on the Spokane MLS for the word “allowance” and found 37 listings offering escrow allowances:
- Buyer to receive $10k roofing allowance w/acceptable offer at closing.
- $4,000 exterior paint allowance to buyer at closing.
- Up to $5,000 driveway allowance, paid at funding.
- With acceptable offer seller will offer $10,000 credit on HUD as a repair allowance to the buyers.
Seems fine and dandy, until you try and get your loan funded. The loan underwriter will shoot this down faster and harder than Dick Cheney taking aim on a quail hunt.
What we are NOT talking about is having the seller contribute cash toward the buyer’s loan closing costs. This is a perfectly legitimate and accepted practice from the lender’s eyes. What we are talking about is the seller leaving a credit, at escrow, for the buyer to make repairs to the house post-closing. Let’s see what the loan underwriting guidelines say…
From CitiMortgage Conforming underwriting manual, Section 806
Escrows for repairs on existing properties are not permitted
No sugar-coating here. Note, escrows are allowed on new-contruction homes only.
From BB&T Mortgage Conforming Underwriting manual, Chapter 4:25
BB&T does not encourage escrowing for completion or repairs, However, if the improvements or repairs cannot be completed for valid reason, i.e., inclement weather or shortages of materials, funds may be escrowed
Seems fair, BB&T is willing to bend the rules for situations absolutely out of control of either buyer or seller.
Even FHA Underwriting Guidelines Page 1-8 Paragraph B of HUD document 4155.1 REV-5
Certain expenses… paid on behalf of the borrower, as well as other inducements to purchase, result in a dollar-for-dollar reduction to the sales price before applying the appropriate LTV ratio. These inducements include decorating allowances, repair allowances, moving costs, and other costs.
Aiy Aiy Captain! No-can-do!
Why would a lender care about this? If your house appraised for the sales price (or more), what does the lender care what the seller does with their money? If the seller was feeling generous and wanted to leave a $100,000 credit for improvement to the new buyer, why is it the lender’s business?
Most lenders business models are such that they lend money to home buyers, immediately sell the mortgages on the secondary market (to investors, for a profit), and take the proceeds from the sale of previous loans to fund more loans for more buyers.
If the lender allowed an “allowance” at closing from the seller to the buyer, until the buyer uses up the credit, the lender can’t sell the mortgage on the secondary market. There is an outstanding contingency on the loan and the secondary market won’t accept it.
The lender is stuck “holding” the mortgage; they can’t sell the buyer’s mortgage to get a cash influx to make more mortgages for more buyers. They have to wait. What if the home buyer drags their feet and don’t use up their $1,000 “carpet allowance” from the seller until 6 months down the line? The mortgage company waits and loses out.
The better solution
The least hassle solution is to do a sales price reduction on the home instead of a credit. If the seller were offering a $10,000 “carpet allowance” on their $200,000 house, instead, set the sales price to $190,000.
A price reduction is easiest on the seller, but often, buyers don’t have the cash necessary to make the improvements once they move in. The alternative is to have repairs done prior to closing, with the seller paying the cost out-of-pocket, or, if the contractor will allow it, have the contractor get paid at closing out of the seller’s proceeds. The seller may not like the risk involved in this (the buyer’s loan may not fund anyway and they’ll have to go back on the market), but, such is life.
From a buyer’s point of view, this should work just fine since, if a seller is offering a credit for carpet or paint, the buyer almost always gets to pick out said items.
Personal Property
Again, in the Spokane MLS today…
- Riding lawnmower, snow blower, microwave and stand, TV, VCR, DVD, Satellite Dish all
included at no extra cost!
and
- 2007 Shelby Mustang GT500 included with a full price offer.
If you are paying cash for your house, great! Who wouldn’t want a new Shelby Mustang in their driveway. Otherwise, a lender won’t allow any personal property to be rolled into the sales price of the home.
Note, real estate law makes a very clear definition as to what “real property” (real estate) is, and what personal property is. Certain appliances, light fixtures, window treatments, exterior plants/shrubs/trees planted in the ground (not potted plants), outbuildings, washer/dryer, awnings, storm windows, etc, are all considered “attached” items and considered part of the real estate. 2007 Shelby Mustang, not so much.
Again, Why would a lender care about this? If your house appraised for the sales price (or more), why does the lender care about personal propety being included in the purchase price?
Consider the first example of the riding lawn mower, snow blower, etc. The agent, borrower and seller may put pressure the home appraiser to “push” the appraised value of the house up in order to include these items in the purchase price.
“Hey appraiser, you and I both know the house is worth $200,000, but it would be really great it you could appraise it at $205,000 so we can include some more stuff for the new owners. And, if you don’t, I might need to hire a different appraiser to do this one for me”.
The lender thinks they are getting a conservative appraisal, when in reality, the appraised value was bumped up a few thousand dollars to be able to include the personal property in the transaction.
More extreme, let’s take that 2007 Shelby Mustang example. Suppose a borrower didn’t care about their credit. A borrower (assuming they qualify for the purchase) could purchase the house with a miminum amount of cash down, and right after closing, could sell the car for $50,000. Then, live in the house for 4 months payment-free, never making any payments to the lender on the home loan, get forclosed on, and walk away with their $50,000 in cash.
Not a result the lender wants to encourage!
The better solution
If you want to purchase personal property from a seller, you should write up a regular bill of sale for those items, buying them subject to your real estate transaction closing.
Hope this helps,
Aaron
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