Negotiating a Sales Agreement: The Financing Contingency
As we saw in the opening example, negotiating strict time-limit contingencies on the buyer for obtaining needed financing should help protect the seller. These days sellers are always concerned (with some good reason) about buyers who talk a good deal, but later can’t come up with the money.
One clause that buyers should insist upon (as seen in Chapter 1) is that they can back out of the deal without penalty, if they cannot secure needed financing. They might want to specify the very term, type, and interest rate of the mortgage that they need.
On the other hand, a wise seller will not want to put the exact interest rate and payment the buyer is to qualify for in the financing contingency. The reason is that interest rates tend to bob around. If the market rate is 5 percent when the agreement is signed, and that’s the rate entered, but it jumps to 6 percent by the time the deal is ready to close, the buyer has a way to back out: he or she can no longer get a 5 percent mortgage.
However, a buyer wants to protect himself or herself from having to go through with a purchase for a higher interest rate (and, accordingly, a higher monthly payment) than he or she feels can be comfortably afforded. Therefore, although the seller may not want to lock in the current interest rate in the sales agreement, the buyer may want to lock in an interest rate.
One way to negotiate a win-win situation for both buyer and seller is to put in a maximum interest rate and payment the buyer will accept. For example, say that rates are currently 6 percent. Perhaps the agreement could call for a loan for “not more than 6.5 percent interest.” This limits the buyer’s risk should rates rise and also gives some assurance to the seller that the buyer isn’t going to use a financing contingency to escape from the deal.
To protect the buyer further, he or she may want to insist that the exact term and type of loan should also be written in as a contingency;
for example, the sale is contingent upon the buyer’s applying for and obtaining a fixed-rate mortgage for 30 years with payments of no more than $ x x per month and an annual interest rate of no more than X percent. If it’s an adjustable-rate mortgage (ARM), that fact and the minimum steps, adjustment periods, margins, and so forth should also be included. (For more information on ARMS, I suggest
you check into my book, Tips and Traps When Mortgage Hunting, McGraw-Hill, 2005.)
Negotiating the Financing Itself.
Frequently, deals are all cash to the seller. The buyer offers a down payment and gets financing for the balance of the purchase price. Sometimes, however, sellers may want to finance their properties themselves. This is especially the case when the homes are paid off and the sellers are retirees. They may like the idea of having the regular income that a mortgage pro vides, at a higher rate than a savings account or CD.
If a seller is willing and able to handle all or part of the financing, there usually are far fewer problems with qualifying. This means that a seller offering financing may be able to negotiate a better deal in terms of price and other terms from a needy buyer. Sometimes financing becomes a deal point. The buyer wants the seller to handle the financing. But the seller doesn’t want to do that.
How can this be negotiated? There are a variety of solutions.
Sometimes the seller can be induced to carry back a second mortgage he or she doesn’t want by:
- Getting a higher price on the sale
- Getting a higher interest rate
- Concessions on time or other conditions in the deal
In other words, if you’re the buyer who needs to have a reluctant seller carry back a second mortgage, it may be to your advantage to negotiate a higher price or better terms elsewhere. Again, this will produce a win-win situation. You get what you want (seller financing) by finding something the seller wants.
A few years ago unscrupulous speculators abused this deal point by pushing it too far. They asked sellers to carry 100 percent of the financing. In other words, they offered nothing down. They would buy “subject to” the existing first mortgage (meaning they didn’t assume liability for it) and the seller would give them a second mortgage for the entire balance. To get sellers to agree, the buyers jacked up the price—often beyond market value. Their plan usually was twofold: first to get hold of the property, rent it out, and wait for rapid price appreciation to overtake them and, second, to sell for a profit, having invested next to nothing. Or the more unscrupulous, having gotten control, would rape the property. They would rent it, keep the rental money, and make no payments to the lender (of the first mort gage) or to the seller (who held the second). By the time foreclosure was completed, they often had up to a year of rent that they had pocketed. The person who got hurt was the seller, who was still responsible for the existing first mortgage and who received no payment on the second mortgage. Some sellers simply lost their properties and their equities. Others got their proper ties back, but at great expense. As a result, many sellers are still wary of financing the sale of their properties.