Legal Hotline: What Size Financing Contingency Does Your Buyer Wear?
Remember when you were a kid and you went to a shoe store and the salesperson asked your finance person (aka your parent, guardian or whoever might have a credit card and be standing near you) what size shoe you wore and the answer was to stand on that metal plate with sliding brackets so the full dimension of your glorious foot, length and width, could be determined with precision? This was necessary because notwithstanding your finance person’s great affection for you, they had no idea what size your foot had become in the preceding 12 months. With this careful measuring, it was possible for the salesperson to return from the backroom with a small selection of shoe sizes, quickly find your perfect fit and get you out the door with time to stop by the ice cream store for a treat that made the outing a celebration rather than a necessity. Without careful measuring, however, trying on shoes to find the right fit became an enduring chore that exhausted you, your finance person and the salesperson.
Picking the correct financing contingency, in light of the revised Form 22A, requires similar measuring by your buyer’s lender (aka finance person) and careful shopping by your buyer, to ensure they have a “just right” fit.
Form 22A, the statewide forms Financing Addendum, was revised March 3, 2021. The old style of financing contingency is still available to buyers but it is now an option rather than the only choice. It is located on Form 22A in paragraph 2, option “A”. The old-style financing contingency gives buyer a financing contingency that never expires by its own terms. To the contrary, if the seller does not deliver a notice triggering buyer to waive buyer’s financing contingency, then buyer will never waive the financing contingency and will continue to be protected by the financing contingency until after the sale fails. Buyer may be incentivized, upon receipt of seller’s notice, to waive the financing contingency because if buyer fails to waive, having received seller’s notice, buyer allows seller the opportunity to terminate the transaction. The old style of financing contingency provides the buyer significant protection, typically through a sale-failed closing date, because it is rare for a seller to actually deliver the notice that triggers buyer to waive the financing contingency. Thus, the old-style financing contingency has the potential to deliver more protection than any other contingency available through the statewide forms system because every other contingency waives, at some point, based on nothing more than the passage of time.
Enter the new style of financing contingency. With the release of the revised Form 22A on March 3, 2021, buyers and sellers gained the ability to negotiate for a different style of financing contingency. The new style of financing contingency is consistent with other contingencies in the statewide forms system in that it waives based on nothing other than the passage of time. Specifically, Form 22A, paragraph 2, option “B” allows the parties to agree that if buyer has not terminated the purchase agreement by a specified number of days following mutual acceptance, then buyer’s financing contingency will automatically waive. If buyer terminates the purchase agreement prior to waiver of the financing contingency, then buyer will recover the earnest money only if buyer is able to provide a letter from buyer’s lender showing three things: 1) that buyer made timely loan application; 2) that buyer had enough cash resources to close the loan if buyer’s loan had funded; and 3) the reason that buyer’s loan could not have funded by the closing date. It is not critical that buyer provide lender’s letter when buyer terminates but buyer will not be entitled to recover the earnest money, following termination, unless and until buyer provides the letter.
Recall that buyer’s financing contingency protects buyer only if buyer makes a good faith effort to obtain the necessary financing but is unable to obtain financing, notwithstanding that good faith effort. Said differently, buyer’s lender’s letter must reveal that buyer made a good faith effort to obtain financing and state the reason why financing would, nevertheless, not be available to buyer. Regardless of whether buyer’s financing contingency is an old-style financing contingency (option A) or a new-style financing contingency (option B), buyer is only entitled to recover the earnest money if buyer can demonstrate, through the production of buyer’s lender letter, that buyer made a good faith, albeit unsuccessful, effort to obtain financing. Significantly, if an “Option B” buyer is going to be able to provide a letter from buyer’s lender demonstrating a good-faith reason that buyer’s loan could not have funded by the closing date, buyer’s loan package must be submitted to the underwriter and be declined by the underwriter prior to expiration (automatic waiver) of the financing contingency. If buyer simply gets cold feet and terminates the purchase agreement without first receiving lender’s denial, then lender’s letter will say that the loan was denied because buyer terminated the purchase agreement and abandoned the loan application. That would not demonstrate the good faith necessary to recover the earnest money.
Because buyer must have confidence that buyer’s lender will timely process the loan application and communicate the unwanted news that buyer’s loan application is declined, if that is true, then buyer must do three things. First, buyer must hire a competent lender. This is not the time to test-drive an unknown lender who promises great outcomes but lacks the track record to substantiate those claims. Second, buyer must quickly provide all documents requested by the competent lender so that lender can assemble buyer’s loan package. Buyer cannot delay “until the weekend” or “until our human resources person is back from vacation” or until any other time other than right now, to locate and deliver, to lender, whatever documentation lender requires of buyer in support of buyer’s loan application. Third, buyer must press the lender to submit buyer’s loan package to the underwriter as soon as it is assembled and well prior to the automatic waiver date of buyer’s financing contingency. Buyer and buyer’s broker must have confidence that buyer’s lender’s underwriter will give the thumbs up or down in time for buyer and buyer broker to terminate the purchase agreement, if necessary, prior to expiration of the buyer’s “Option B” financing contingency.
To circumvent all of the stress and risk associated with lender’s timely processing, of course, buyer could simply work with a lender to secure an underwriting pre-approval of buyer’s loan, prior to making an offer to purchase seller’s home. With that, buyer will know, prior to mutual acceptance, that buyer’s lender has approved buyer for financing subject only to: title insurance; homeowner’s insurance; and an appraisal that supports the purchase price.
With both “Option A” and “Option B”, buyer and seller will negotiate for buyer’s preservation of the low appraisal provision set forth in Form 22A (paragraph 5). The provision for negotiating preservation of the low appraisal provision is found in subparagraph iii of “Option A” and subparagraph ii of “Option B”. In both cases, buyer preserves the protection of the low appraisal provision, even if buyer waives the financing contingency, by marking the “will not” box (or by marking neither box because the default, in that case, is to “will not” and preservation of the low appraisal provision).
So how is determining the right financing contingency for buyer akin to shoe shopping when you were a kid? Because the financing contingency that best fits your buyer will depend upon the size of your buyer’s financial qualification and ability to timely obtain financing. Factors that will influence your buyer’s financing contingency size will include things such as whether the buyer has underwriting preapproval for their loan, how qualified buyer is to obtain the loan, the competency of buyer’s lender, the competition for seller’s home, etc.
Consider that in the most competitive seller’s markets, many buyers are choosing to waive their financing contingency altogether because seller will not tolerate the risk that buyer may announce, at closing, that buyer was unable to secure financing and thus, be legally excused from performance of the transaction. In order to be competitive, buyer may choose to waive a financing contingency in order to gain the opportunity to purchase seller’s home.
Thus, buyer’s choice of financing contingency is not only between Form 22A, “Option A” and “Option B”. Buyer’s choice also includes no financing contingency at all, or perhaps, no financing contingency but a low appraisal contingency instead. The “size” of financing contingency buyer includes as part of buyer’s offer will likely reflect, the competitiveness of the market. Additionally, if buyer already has underwriting preapproval and the only unknown with respect to buyer’s financing is the appraisal, that will affect the size of financing contingency buyer needs and give buyer flexibility to retain enough protection while also giving seller security in buyer’s ability to close the transaction. If buyer is less certain in buyer’s ability to obtain financing and the strength of the market will allow, buyer may be able to include in buyer’s offer a big financing contingency that protects buyer all the way through a sale fail.
Of course, buyer is not at liberty to dictate the size of financing contingency that will necessarily be part of the purchase agreement. Buyer should be prepared for seller to counter buyer’s offer to include a “smaller” financing contingency than buyer offered. Buyer must be comfortable with the “fit” provided by the financing contingency included in seller’s counter or buyer cannot accept seller’s counter. Simply put, the revised financing contingency provides more negotiation opportunities to the parties than previously existed. For the seller who needs security in knowing that the sale is likely to close, negotiations may result in a slightly lower price with an “Option B” financing contingency or even no financing contingency but a low appraisal addendum (Form 22AA) from a buyer who has underwriting preapproval. For the buyer who cannot tolerate the risk of losing earnest money if financing is not available, concessions around some other term of agreement may allow the buyer to gain the protection of a big financing contingency.
Buyer will only know which financing contingency “fits” by measuring buyer’s financial ability. Buyer’s competent lender is the only person who can do the necessary measuring. It is more important than ever that buyers get to a competent lender, get properly measured and even preapproved if possible, before submitting an offer. Only with the knowledge of what size financing contingency buyer needs, will buyer and buyer broker have the ability to utilize all of the negotiation tools available to them. ◊
Annie is the Washington REALTORS® Legal Hotline Lawyer. Email the Legal Hotline Lawyer directly at legalhotline@warealtor.org or leave a message for the Hotline Lawyer at (800) 562-6027.