Finance Contingencies – Read ‘Em or Weep

A lot of people need a bank loan to buy real estate. They want a contract that says if they do not get the loan they want, they don’t have to buy the property. That is known as a finance contingency.

Most preprinted residential sale contracts either include an optional finance contingency or have available a preprinted financing contingency addendum a buyer can use. The most widely used Florida sales contract forms all include an optional finance contingency which Realtors can utilize when the buyer so requests.

The problem with preprinted finance contingencies, as with any preprinted contract, is that the form may not do what the buyer wants. The buyer may not really understand how contingency works. 

Good examples are the finance contingency in the most commonly used local sales contract form prepared by the Naples Area Board of Realtors (“NABOR”) and the finance contingency in the form sales contract utilized most frequently in Florida prepared by a joint committee of Florida Realtors and Florida attorneys known as the FR/BAR contract.

Finance contingencies in those two contracts are really different. Let’s take a look at the terms of those contingencies.

The NABOR contingency provides that the buyer’s obligation to purchase is contingent upon the buyer obtaining a loan secured by a mortgage on the property being purchased. It provides options for the buyer to elect conventional, VA, FHA or other financing. It further provides options to include an initial or fixed rate of interest, an amortization term (30 years if left blank) and a deadline for the buyer to apply for the loan (five days from the effective date of contract if left blank).

The contingency mandates the buyer make a good faith, diligent effort to obtain the loan and meet all requirements of the lender. Those obligations are obligations of good faith, and can be waived, but the contract reminds the buyer that the buyer has to do those things. The contingency includes a deadline by which the buyer must waive the contingency. If not timely waived, the seller has the right to terminate the contract and buyer gets back the deposit.

If the buyer waives the contingency, the contract effectively becomes a cash sale, and if anything goes wrong with the loan, the buyer must either be in a position to close without the loan or risk losing the deposit. The NABOR contract provides that if the buyer defaults, such as failing to close in a “cash” sale, the seller’s damages are limited to forfeiting any deposit.

If buyer does elect a financing contingency under the NABOR contract, the buyer gets a bit of a break. The contract provides that if the lender needs additional time due to delay caused by the lender or to comply with government requirements and the buyer waived the contingency, the buyer may extend the closing date up to 10 days and the seller has to go along with that. 

Under the NABOR contract, the buyer can terminate early for failure to obtain financing, but only if the buyer (a) has a statement of adverse credit action from the lender confirming the financing was denied on grounds the property was unacceptable to the lender or the buyer financially failed to qualify or, (b) provides other evidence from the lender that buyer timely made the loan application, made diligent and good faith effort to obtain a loan but has received neither loan approval or denial. 

The FR/BAR finance contingency starts out same as NABOR. As with NABOR, that contingency includes checking the box options for type of loan, interest rate, length of loan and deadline to apply. It has the same five-day deadline from contract effective date as NABOR for making the loan application and requires good faith diligent effort to obtain. 

Then it differs. The FR/BAR contract is contingent on buyer obtaining loan approval and not an actual loan. The contract includes a fill in the blank deadline to obtain loan approval (30 days if left blank). The buyer is required to notify the seller within the loan approval period of whether the buyer has or has not obtained loan approval.

If the buyer timely notifies the seller that the buyer has not obtained loan approval or is unable to meet the requirements of any loan approval, the buyer may terminate the contract by written notice to seller prior to the end of the loan approval. If the buyer fails to timely notify the seller of failure to obtain loan approval, the contract becomes a cash contract, and the finance contingency evaporates. The seller has a right to terminate the contract within three days after expiration of the loan approval period, and the buyer gets back the deposit.

If the buyer gave timely written notice of loan approval and something goes wrong with the loan, the buyer is in default under the contract if the buyer fails to close, even if the failure is due to loan issues. However, the buyer gets off the hook if failure to close is due to the seller’s default or a property related condition of the loan approval (excluding appraisal) has not been met. An example of a property condition that might stop loan funding is damage to the property between contract date and closing.

The FR/BAR contract does not limit the seller’s right to forfeit deposit if the buyer defaults. It also allows the seller to sue the buyer. Since most buyers think their only risk is losing their deposit, it behooves a buyer to read and understand an entire contract and interplay of all provisions before signing.

The NABOR contract truly makes closing contingent on the buyer obtaining a loan unless the buyer waives the contingency. The FR/BAR contract is more dangerous. If the buyer does not terminate the contract during the contingency period for failure to obtain loan approval, closing is no longer contingent on financing.

Preprinted contracts often engender a false feeling of security. Financing contingencies are but one example.