The real estate market is tough right now. High interest rates make buying more expensive, but low inventory is driving multiple offers and bidding wars. Many of my clients are now making offers with no loan contingencies. This can be quite nerve-wracking, and there are some risks. Should you offer to purchase a home with no loan contingencies? Let’s take a deeper look.
What is a no loan contingency offer?
When making an offer to buy a home, you would normally include certain contingencies, meaning that the offer is contingent on certain things taking place. Common contingencies include inspections, such as a home inspection and a pest inspection, an appraisal to verify the value, and a loan contingency to confirm that you can get the loan you need to buy your new home.
In a seller’s market, where there are few listings and many buyers, your real estate agent may ask you to waive contingencies, or make a no loan contingency offer. This means that there are no conditions to meet in order for you to buy the property. You are committed to completing the transaction. If for some reason you can’t complete the deal, the seller can keep your earnest money deposit to compensate for taking the property off the market.
Think of this from the seller’s perspective. The offer with contingencies is an offer to maybe purchase the home, but a no contingency offer is more certain to close. You, the buyer, are confident in your ability to close the transaction.
A Deeper Look: How to Make a Successful Offer in a Competitive Market
What are the Risks of a No Loan Contingency Offer?
The most obvious risk of a no loan contingency offer is that if you fail to close, the seller may have the right to keep your earnest money deposit. A typical earnest money deposit is 3% of the purchase price, so on a $1 million home that would equal $30,000. Walking away from that would be painful.
Loan approval is not the only contingency that buyers are being asked to waive today. You might also be asked to waive inspections or the appraisal. Since there are different elements that might be waived in an offer to purchase, let’s look at each of them.
The purpose of Inspection contingencies is to allow you time to hire experts to confirm that the home is in good, livable condition with no unknown defects. A home inspection examines all of the structural and mechanical features of the home and points out any deferred maintenance that might cost you money to remediate down the road. A pest inspection searches for evidence of any pests, such as termites, that might cause rapid deterioration of the structure, recommends treatment and remediation where needed, and estimates the cost of repairs.
In some states you may need a survey as well, to verify the boundaries of the lot in your new home and ensure that there are no unknown encroachments on your lot, and that you do not have improvements encroaching on others.
Waiving inspection contingencies, therefore, means that you are accepting the property as-is. If there are any defects or expensive repairs needed, you will either have to walk away from the transaction (and your earnest money deposit) or make the repairs at your own expense after you close escrow.
The appraisal contingency serves two purposes. The first is that you probably want to confirm that you are paying a fair price for your new home. The appraisal may not be a definitive confirmation, but it helps. In my practice, when appraisals come in at or above the purchase price, buyers feel very good about it. When it comes in lower than the purchase price, buyer’s remorse often sets in.
However, the second purpose of the appraisal matters more. If you are putting only 20% down or less, a low appraisal might impact the cost of your mortgage, or even your ability to qualify. This is because when calculating the loan-to-value ratio of your loan, the lender will compare the loan amount to the appraised value or the purchase price, whichever is lower. This can impact your pricing on your loan, or even cause it to be denied.
Solutions for a Low Appraisal
If your purchase price is $1,000,000 and you are putting 20% down, you would apply for a mortgage of $800,000. If the appraisal came in at $900,000 one of three things might happen.
- The lender reduces your loan amount to $720,000 and you have to come up with an extra $80,000 in cash for the down payment.
- The loan amount stays the same, but now your loan-to-value ratio is higher than 80% ($800,000 / $900,000 = 88.9%.) You will have to pay for mortgage insurance and your interest rate might be slightly higher.
- If you have an appraisal contingency, then you can try to renegotiate the purchase price based on this new information. If you don’t have an appraisal contingency, you can ask the seller to reduce the price, but they can say “no,” and you still have to complete the transaction, or else potentially lose your earnest money deposit.
Waiving the loan contingency means that you are totally confident you can get the mortgage at the amount, interest rate and price that you need to complete the transaction. If for any reason you are turned down for the loan, or if you suddenly can’t qualify because interest rates jump after your offer is accepted and before you lock your interest rate in, you may lose your deposit.
Avoiding Risks of a No Loan Contingency Offer
The most certain way to avoid putting your earnest money at risk is to not waive contingencies in your offer. In a hot sellers’ market, however, that might mean your offers will be less successful; you may not get the home you want.
If you must submit a no loan contingency offer in order to be competitive, keeping the other contingencies (inspections and appraisal) gives you an opportunity to either back out or renegotiate should you learn anything about the home that makes it unattractive.
Many real estate agents today are recommending that offers be submitted with no contingencies at all, especially if you are likely to be competing against all-cash offers. If you love the home it might be the only way to make your offer stand out. This can be very risky, however.
Every home buyer who needs a mortgage has something that limits the amount of money they can borrow. It could be income, debt, assets or credit. One or more of these factors will limit how much you can qualify for.
For instance, if you have only enough cash for a 3% down payment plus closing costs, we can find you a conforming loan. Let’s say we have you pre-approved for your purchase at $500,000 with 3% down. If you have a solid pre-approval, then making a no loan contingency offer is relatively safe. Your loan amount would be $485,000. Now assume the appraisal comes in at $480,000. The most your lender will lend you is $480,000 x 97% = $ 465,600. You now need a down payment of $34,400 to make up the gap between the loan amount and the purchase price. Do you have that much extra money? If you have an appraisal contingency, you can walk away with your deposit or renegotiate the purchase price. If not, you could lose your deposit.
Let’s say you were planning on putting 20% down in the same example. Your new loan would be $400,000. With 20% down you would have no mortgage incurance. But then the appraisal comes in at $480,000. To stay under 20% down your loan amount would be reduced to $384,000. You would now need to come up with an additional $16,000 more than you expected to close the gap. You don’t have it? No worries, because even with the low appraisal you are now at 83.3% loant-to-value with the $400,000 loan.
But wait. Guess what? Your interest rate is now a little higher, and you’ll need mortgage insurance. Not a problem, except that now, your debt-to-income ratio is too high because of the higher monthly payment, and your loan is declined.
The point is, if you want to make a no loan contingency offer and waive your appraisal and inspection contingencies too, you should stay well below your maximum qualifying price.
Which Lender is Best for a No Loan Contingency Offer?
The lender you select matters more if you’re going to make this kind of offer than in most other situations. The certainty of the approval and the advice and guidance of an experienced, competent mortgage advisor is crucial, and could save you the pain of losing a great deal of money in your deposit. No matter which lender you choose, if you want to write a no loan contingency offer, only work with a mortgage advisor who:
- Has at least five years of full-time mortgage lending experience
- Has access to multiple lenders, in case one lender cannot make your loan (in which case they can flip your loan to a back-up lender)
- Can explain where your qualification is tight and where you have room
- Can (and is willing to) guide you with each offer you make, re-running the numbers and the prequalification for each home
With a solid preapproval in hand and the confidence to make a safe no loan contingency offer, you have a much better chance of being the successful buyer of the home of your dreams.
Casey Fleming, Author The Loan Guide (2014) and Buying and Financing Your New Home, (Available as an eBook now)
Mortgage Advisor, Silicon Valley Mortgage
Property Manager, Bright House Properties
My Blog: www.loanguide.com
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Follow me on Twitter for interest rate updates: @TheLoanGuide
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