This is not legal advice, and you should not rely upon it. For legal advice, consult an attorney, not a blog.
In today’s low-interest-rate, low-inventory, recovering-from-the-bubble housing market, there are more buyers than there are sellers. This leads to routine instances of multiple offers, where only one buyer will get the home under contract and the rest will be disappointed. So if you’re looking to buy, you need to be thinking about how to handle this likely scenario when you find “the one.” You want to be the sole winner, not one of the several losers.
There are many ways to enhance an offer, many of which are discussed in the link above. However, these are generally “ham-fisted” attempts to strengthen the offer that are routinely employed by real estate agents and that really are not that effective. For example, putting down a large amount of earnest money certainly doesn’t hurt, but (a) the seller wants to sell, not keep the earnest money, and (b) presumably your competitors will bump up their earnest money as well. Accordingly, increasing the earnest money is not a particularly effective way of strengthening your offer.
In a recent post, Ardell discussed the relationship between the “must appraise” clause and the recent increase in housing values. She suggests that buyers are now waiving the “must appraise” clause in order to strengthen their offer. In reality, removing the “must appraise” clause from the financing contingency is an ineffectual way of strengthening the offer. [That said, Ardell is absolutely correct in warning buyers about entering into a contract where they will have to make up the difference between the sale price and appraised value, a caution that fully applies to this post as well.] If a buyer simply eliminates the “must appraise” clause of the financing contingency, the buyer really hasn’t strengthened the offer at all. In fact, just the opposite.
Per the terms of the financing contingency, the buyer is relieved of the obligation to buy the home, and is entitled to a return of the earnest money, if the buyer’s lender is unable to fund the loan per the terms of the contingency (most commonly the lender will provide 80% of the sale price). When the financing contingency includes the “must appraise” clause, the buyer does NOT automatically get an “out” if the home appraises for less than the sale price. Rather, the seller has the contractual right to “massage” the issue and to keep the sale on track. If there is no “must appraise” clause, the seller loses this contractual right. So if the property doesn’t appraise, where the contract includes a financing contingency but no “must appraise” clause, the loan simply does not fund and buyer is at least arguably entitled to a return of the earnest money back.
Why “arguably”? There would be a degree of ambiguity in the contract about whether the buyer “had sufficient funds to close” if there is no “must appraise” clause. The buyer would argue that the “sufficient funds” refers to the buyer’s portion of the sale price as set by the contract (e.g., if the contract requires 20% down and the sale price is $500k, then buyer must have $100k on hand). The fact that the property did not appraise does not change the buyer’s obligations. Rather, it simply means that if the property doesn’t appraise, the loan will not fund, and thus buyer is entitled to the protections of the contingency. The seller will of course argue otherwise.
But the goal here is to strengthen the offer, not set up a spitting match with the seller. That being the goal, the best way to strengthen the offer? Waive financing entirely. Does this mean that the buyer is barred from financing the purchase? Of course not.
Well, not “barred,” but not allowed either. Absent a financing contingency, the buyer represents in the form contract that the buyer is not relying on any contingent source of funds, such as a loan, to complete the purchase. So if the buyer simply excludes the Form 22A Financing Contingency from the offer, but is planning on getting a loan, the buyer will be in breach of contract as soon as the contract is signed. This would allow the seller to retain the earnest money and sign a contract with a new buyer. Unlikely, but very very possible. So a prudent buyer should include an additional term in the offer noting that buyer will be financing the purchase. Thus a pre-approval letter will be essential as well.
There is no prohibition in the contract on getting a loan. But if the buyer can’t get a loan, then buyer will forfeit the earnest money. An offer without a financing contingency is considered a “cash offer” by sellers (and their agents). This means that the appraisal is irrelevant in regards to buyer’s obligation to complete the purchase. And Ardell is right, THAT is the seller’s goal, because bidding wars among buyers can elevate the price beyond “market value.”
Sellers don’t want the transaction to derail because of a low appraisal. But you don’t get there simply by eliminating the “must appraise” clause. You need to forgo the financing contingency entirely. Which of course increases the risk to the buyer’s earnest money. If the buyer forgoes the financing contingency but must finance the purchase, and if the financing fails for ANY reason, the buyer loses the earnest money, period. In other words, the risk of a failure of financing lies on the buyer, not the seller, where there is no financing contingency.
If the property does not appraise for the sale price, the buyer will either have to go out-of-pocket for the difference (as noted by Ardell) or buyer will forfeit the earnest money. So if you’re thinking of going this route, make sure you understand and accept this risk.
Should you forego the financing contingency, but offer a small amount of earnest money? This is a good option, in part because “CASH OFFER!” has such an appeal to sellers (and their agents). There is a good chance that the seller will not even appreciate the need for a large amount of earnest money absent a financing contingency. If seller does appreciate that issue, then at a minimum you have a good chance of getting a counteroffer from seller. And if there are multiple buyers, that is about all you can ask for.
So good luck with the offers, and strengthen them in a focused and effective way, as long as you understand the resulting additional risk.
Wouldn’t creating a “cash offer” knowing that you need to get bank financing be a little misleading? Cash offers tell the seller that you could close tomorrow if the closing documents are ready. Stating that you are making a cash offer and then waiting on final loan approval would be similar to a seller stating that the buyer can have immediate occupancy when the seller moves out. Then after closing the seller states they need 30 days to close on their next home. How would the buyer feel?
Thanks for the comment, Simon. First and foremost, I will use the phrase “cash offer” using the quotation marks to mean an offer that does not include a financing contingency but where the buyer must finance the purchase to complete it.
I think your point does a great job of illustrating one of the many differences between an agent and a lawyer. Agents are by definition COOPERATING brokers. Thus they have a significant degree of concern for the other side.
Lawyers, in contrast, have a duty to their client only (more or less, there are some minimal obligations to others, such as I must not make a false statement of material fact). Accordingly, I am generally not concerned with the other party. I am concerned about, and am responsible for protecting and advancing the interests of, my client only. (As an aside, I certainly could not tell a seller that my buyer client had the cash on hand to close the purchase if that was not in fact true, but here I am discussing submission of a “cash offer” with no other indication or information about my client’s funds.)
So you see making a “cash offer” as unfair to the the opposing party, and thus inappropriate. In other words, you believe the Form 22A is necessary not just to protect the interests of your client, but also without it the seller may misunderstand the terms of the offer. And this flows in part from the common understanding of agents – or from my perspective a misunderstanding – that any offer without a 22A is a true cash offer where buyer will not need to secure financing.
In contrast, I see the terms of the offer as speaking for themselves. If there is no Form 22A, then all that means is that the purchase is not contingent on financing. Thus if buyer can’t get financing, buyer will forfeit the earnest money. If seller misunderstands the offer, and that misunderstanding inures to my client’s benefit, then I think I’ve done a good job.
As to your hypothetical: How would my buyer clients feel? Pissed off, but more importantly with a clear legal right that the seller has infringed upon. That is not analogous – from a legal perspective – to submitting a “cash offer.” With such an offer, the buyer does not infringe upon any legal right held by the seller. A seller refusing to relinquish possession after closing? That is an entirely different matter.
In the final analysis, you are concerned about the seller’s “feelings.” I am not. Otherwise I would not be a very good lawyer.
Simon, in fact you raise a good point that I missed initially. I now appreciate (I had forgotten about) the term in the contract in which buyer represents buyer has funds on hand and is not relying on a loan absent inclusion of a financing contingency. So it’s not just the seller’s feelings at issue. If a buyer simply omits a financing contingency but does not indicate somewhere else (such as an addendum) that the buyer is financing the purchase, then the seller’s legal rights have been infringed as well. A seller would be entitled to claim breach immediately, retain the earnest money, and move on to another buyer. So needless to say it is prudent – an understatement! – to inform the seller that the buyer is financing the purchase. Omitting the financing contingency thus does not render it a “cash” offer, but it does eliminate the appraisal issue, which in a multi-buyer situation has huge value to the seller.
Exactly my point! The issue here is simply the elimination of the finance contingency, rather than hiding the truth behind a misleading “cash offer” statement.
Why not reveal that you are purchasing the property with bank financing and then remove the contingency with a statement in an addendum. The seller now knows the true terms of the sale and the buyer has a stronger offer and bears the risk of losing the escrow deposit if financing does not mature.
Yes, that would work. Although I prefer to keep an offer as simple as possible, so I would omit the 22A and include a simple statement in an addendum that the buyer is financing the purchase. Done and done.
Great tips! This is should be done, however, to strengthen the offer/transaction, and not just for careless negotiations.
Interesting post but it still leaves me unsettled for my buyer clients. In Southern California at least 80% of all listings request Proof of Funds for cash offers and most buyers’ agents include Proof of Funds for all clients including those financing to prove the buyer has sufficient funds for the down payment and closing costs. Submitting a “cash offer” would do us no good if the client doesn’t have funds to support a close on the property with no financing. I have seen all cash offers morph into financed purchases once escrow is opened but I think this is a disservice to those buyers who submitted a financed offer in good faith.
At this point home buying has become a game of one-ups-manship in the buyer giving up their traditional rights and protections and the seller trying to find more ways to eliminate those rights. There was a time when homes actually did sell with all of the contingencies and protections in place to protect both the buyer and seller. Instead the new home selling process puts everyone at risk, most importantly the buyer, with little or no reward should the escrow go south.
I am not a lawyer so I never give legal advice, but I do everything possible to protect my clients’ best interests which includes their deposits. I don’t believe, and I tell my clients this, that making the single largest purchase of their lives should entail unnecessary risk. I wish other agents and lawyers would do the same.
There is no question, Catherine, that this sort of strategy is, in the big picture, bad for buyers generally. But we take the market as we find it, and right now there are more buyers than houses. So I need to do everything I can for my client to beat the other buyers. And that means assuming more risks and giving the seller the upper hand in the contract. As long as my clients are aware of the risks they are assuming, I have no problem with doing so. Again, it is the state of the market.
Note that I am not concerned about other buyers. They have their own representation and presumably are doing what is in THEIR best interests. My concern is with my client. Like Simon’s comment and my response, this further illustrates a cultural difference, in my opinion, between lawyers and agents.
IME, cash offers are sometimes recognized as superior and sometimes not. The second circumstance happens with an unsophisticated seller who has an unsophisticated and/or distracted agent. I’ve had it happen. I spell out in the contract that my all-cash offer means no contingency, no need to appraise, etc, and the seller can’t figure it out.
Also, the notion that earnest money can be kept by the seller is discussed at length elsewhere on this blog. Suffice to say that possession is 9/10ths of the law and normally the buyer’s agent keeps control of the earnest money. One more reason that earnest money in general is a bit of a chimera.
That’s a good point, Mike.
That said, as to your second paragraph, I have no problem at all chasing the earnest money when my client is clearly entitled to it, regardless of who has possession. The contract includes an attorney’s fees provision, and there are times the other party is in la-la land and is simply wrong in claiming to be entitled to the funds. I don’t care who has possession of them, in that instance I will go after them. And eventually get them, with my attorney’s fees paid by the other party. I don’t think earnest money is a chimera at all, at most a lion who may be subdued and then held accountable for the harm caused.
Right, and I’d love to have you represent me, but I’m in another part of the country 😉
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Im not so sure why there is such an emphasis on the use of adequate cash offers, as Mike stated sometimes they work sometimes they don’t. I agree the competitive alignment seems to completely disregard all parties protectiveness, and in this day and age and to be honest thing looks set to get worse. That aside, good post and a good read.
Mark Wilson
I agree with Catherine that the buyers home purchase should not include unnecessary risks, unfortunately after they loose one or two or even more homes to other buyers they start to consider the risk as a way to get their offer accepted.
Great…thank you for sharing the post
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Catherine & Joe have hit the hammer on the head there… think buying a house should never have a risk element to it!
I agree with you Lucy – especially if the purchase is for your personal residence. Now if this is an investment property, I believe there can be a higher degree of risk. By using more bank leveraging, an investor can dramatically increase their cash on cash return – but this can bring added risk, of course.
That is certainly a rational and reasonable opinion, Lucy. But in this market, avoiding ALL risk will likely mean having a harder time getting a home under contract, because there are other buyers willing to assume some risk in the interests of getting the house. Ultimately, it is up to each potential buyer to determine how much risk, if any, she wants to assume, in exchange for strengthening the offer and thus increasing the chances of getting the house. And it is the professional’s job – ideally a lawyer, since this is the practice of law – to explain to the buyer the risks being assumed so that the buyer is fully informed.
This is a great post with some great information, thanks
Thank yous for this information. I am selling a house and there seem to be many offers. I’m glad that I found your post.
Great info and great response Catherine
Graham, seattle
Strengthen your offer by also prequalifying with the listing agents preferred agent. Also include a letter with your offer on why you want to purchase the home. It adds a great personal touch to the offer.
Thanks Andrew. I think by saying “the listing agent’s preferred agent” you mean a loan originator who has a close relationship with the listing agent. And you’re right, but not for the reason you suggest. Several thoughts:
1) “Prequalifying” does not require the same level of scrutiny as “pre-approval.” So generally speaking, you’re better off with being pre-approved, not just pre-qualified.
2) Particularly when compared to a known local lender, like Cobalt, I think the “listing agent’s” loan originator adds little additional value. However…
3) The listing agent is almost certainly getting a referral fee from the loan originator. So when the buyer uses that loan originator, it increases the listing agent’s potential payday. And that is certainly likely to be of assistance if there are other potential buyers. So you’re right, because of this referral relationship, not because the pre-approval has inherently more weight when coming from someone with whom the listing agent has a relationship.
Hi Craig,
Great post. Well written and in-depth. However, I do respectfully disagree with the argument that waiving the appraisal contingency doesn’t strengthen and may actually weaken an offer.
I wrote a blog post on my blog about why I believe waiving appraisal contingencies may strength offers and mentioned your arguments in it. Feel free to check it out 🙂
Waiving Appraisal Contingencies Strength Offers
Thanks,
Kevin
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