Analyzing the Financing Contingency

ORLANDO, Fla. – Members often call the Florida Realtors® Legal Hotline after a loan is denied and ask whether the financing contingency protects the buyer. There are a lot of moving parts to that clause. There are multiple timelines, five defined terms (words that are given a definition specific to this contract), and lengthy sentences. Due to the complexity of this clause, this article will come in two parts. This article will give an overview of the clause. The second article (in the July edition of the legal news) will focus on some common questions that arise.

Here’s an overview of the Florida Realtors/Florida Bar Residential Contract for Sale and Purchase Financing clause, which is found in Section 8 of the contract:

The first decision the financing contingency presents is whether the buyer will have any protection if they can’t secure a loan by closing. There are two options. The first is just one sentence at section 8(a): “This is a cash transaction with no financing contingency.” If the parties select this option, the buyer is committed to bringing all the money to closing and has no protection if unable to do so.

The second option at section 8(b) is a contingency designed to protect the buyer if the buyer applies for a loan but can’t get both loan approval and an appraisal satisfactory to the lender before the loan approval deadline.

Under this second option, the buyer has some work to do. The first step under the contract is for the buyer to apply for the loan. The contract provides “Buyer shall make application for Financing within ___ (if left blank, then 5) days after Effective Date...” Remember, these are calendar days, so the buyer needs to get to work quickly, especially if there’s a weekend included in those days. For example, if the effective date is Thursday, then the buyer has until the following Tuesday to apply.

The buyer needs to apply for the specific type and amount of loan described in the contract. The loan amount can be found in section 2(c) on the first page of the contract. This will be a dollar amount or a percentage of the purchase price. Either way, the buyer will have a specific number they’re asking the bank to lend. In addition to amount, the contract also describes the loan type (conventional, FHA, VA or other), rate (fixed, adjustable or either), an interest rate cap (not to exceed ___ %), and a term (30 years, for example, which is the default unless the parties negotiate a different timeframe).

Once the buyer has applied for the specific loan described in the contract, they must “use good faith and diligent effort to obtain approval of a loan meeting the Financing and Appraisal terms of Paragraph 8(b)(1) and (2), above.” That generally means they need to comply with any reasonable requirements the lender has, and the contract provides a few examples when it describes diligent effort as “...timely furnishing all documents and information required by Buyer's mortgage broker and lender and paying for Appraisal and other fees and charges in connection with Buyer's application for Financing.” That is not an all-inclusive list, so the gist is that the buyer needs to be actively seeking the loan approval and appraisal in a timely manner. Additionally, if the seller or “broker” (includes either broker per the contract – listing side and buyer’s side) sends a written request for an update on the loan application, the buyer needs to respond and give an update.

After applying for the loan and using good faith diligent effort to obtain it, the next key event could be obtaining loan approval. Notice that “loan approval” is defined in the contract as BOTH the buyer receiving approval of the specific loan described in the contract AND “...an appraisal or alternative valuation of the Property satisfactory to lender, if either is required by lender, which is sufficient to meet the terms required for lender to provide Financing for Buyer and proceed to Closing.” Note that the loan approval will likely be called something like a conditional loan approval or conditional loan commitment, and they typically have conditions that need to be met before closing. As for the appraisal, this broad definition leaves questions for the lender. Will they require an appraisal? If not, then their lack of requiring one seems to check the box. If they are requiring an appraisal or alternative valuation, then the question is whether the lender is satisfied with what they obtained or not (regardless of the amount).

If the answer to both questions is yes the buyer received some form of approval AND they received some notification that the lender is satisfied with whatever appraisal or alternative valuation the lender obtained (if any), then the buyer “shall notify Seller of same in writing prior to expiration of the Loan Approval Period.”

However, if the lender hasn’t provided both items (loan approval + appraisal), then the buyer has two options:

• Option 1: “Buyer may terminate this Contract by delivering written notice of termination to Seller prior to expiration of the Loan Approval Period.”
• Option 2: “...if Buyer is unable to obtain Loan Approval within Loan Approval Period but Buyer is satisfied with Buyer's ability to obtain Loan Approval and proceed to Closing, Buyer shall deliver written notice to Seller confirming same, prior to the expiration of the Loan Approval Period.” Note that the buyer is assuming some risk with option 2, so they should be confident they will eventually get loan approval before going down that path.

So far, we’ve discussed three scenarios that take place before the loan approval period ends. The buyer provides WRITTEN NOTICE that they received loan approval. Or, buyer provides WRITTEN NOTICE that they don’t have loan approval and are cancelling the contract. Or, the buyer provides WRITTEN NOTICE that they don’t yet have loan approval but are confident they’ll get it before closing and are continuing forward with the contract.

Why did I capitalize written notice three times above? Because there’s a fourth option that some buyers overlook. “If Buyer fails to timely deliver any written notice provided for in Paragraph 8(b)(iii) or (iv), above, to Seller prior to expiration of the Loan Approval Period, then Buyer shall proceed forward with this Contract as though Paragraph 8(a), above, had been checked as of the Effective Date.” What does section 8(a) say? That’s the “cash transaction with no financing contingency” option. In other words, the buyer is supposed to send one of the three written notices described in the last paragraph. A written notice is simply a letter, email or fax sent by the buyer, buyer’s attorney, buyer’s broker or buyer’s sales associate (see section 18(O) of the contract for notice details) that informs the seller which option the buyer selects. If there has been no written notice, then regardless of the status of the loan application, the deal converts to a cash transaction as soon as the loan approval period expires.

Note that if the buyer failed to provide any of the written notice options before the loan approval period expired, then the seller will have a three-day window after loan approval where the seller can cancel the contract and give the buyer the deposit back if they want.

Now that the loan approval period has expired, the only remaining question is what protection, if any, a buyer still has. If they haven’t cancelled but provided one of the remaining written notices (approval received or going forward in hopes they will receive approval soon), then there’s a thin layer of protection remaining. Section 8(b)(vi) provides that if the deal doesn’t close after the buyer provided a written notice before the loan approval period expired, “...the Deposit shall be paid to Seller unless failure to close is due to: (1) Seller's default or inability to satisfy other contingencies of this Contract; or (2) Property related conditions of the Loan Approval (specifically excluding the Appraisal valuation) have not been met unless such conditions are waived by other provisions of this Contract; in which event(s) the Buyer shall be refunded the Deposit, thereby releasing Buyer and Seller from all further obligations under this Contract.” So, for the most part, the buyer’s deposit is at risk unless the seller defaults or the lender changes its mind about closing the loan due to property related conditions.

Of course, if the buyer neglects to provide a written notice, then it’s as if it’s been a cash transaction with no financing contingency since the effective date. In other words, there’s no protection if the buyer can’t come up with the funds to close.

Joel Maxson is Associate General Counsel

Note: Information deemed accurate on date of publication

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