Purchase Implosion: Pre-approval letters worth the ink?

Nearly everyone has had a personal experience of a deal falling through via the other side of the transaction not performing. It is hard to swallow when you have no control over the other party or their financing efforts. Especially bad, the call to your client who is in boxes and ready to move within hours. It takes guts to make the call and is character building.

The dreaded phone call: “….hate to bring you bad news, but our transaction has fallen through, and ….”

Chew on this scenario:

A transaction is stopped in its tracks just hours before it is slated to close. Seller has already signed closing paperwork and escrow is waiting for lender documents to have borrower sign and then proceed to close the transaction as scheduled. Escrow is then notified that the deal is apparently dead. Why? Escrow is informed by the agents that buyer’s financing fell through. Buyer’s financing addendum gives the borrower x amount of days to obtain financing, which was written to expire the day of closing. As is tradition, the selling agent provided a pre-approval letter (not pre-qualification) at the time of the offer.

In a sentence in paragraph #2 of the Financing Addendum Contingency (NWMLS Form 22A) it states:

“A letter from the lender generated or dated at or prior to mutual acceptance shall not constitute a letter of loan commitment which complies with this paragraph.”

1) Should the listing agent and seller fight for the earnest money?
2) What do you find would be some of the transaction management pitfalls that could have been avoided?
3) Is the buyer fully in compliance or did they fall short of a duty to act in a timely manner. Time is of the essence.

60 thoughts on “Purchase Implosion: Pre-approval letters worth the ink?

  1. 1. Depends. We don’t have enough information to know if the financing issue is because of buyer’s failure to do their duties under the contract or if this is due to an issue that is no fault of the buyer’s such as a change in lending guidelines. Sometimes a buyer does everything they should and still can’t get financing.

    2. Extension of the financing addendum beyond the closing date would be a good place to start–if the seller will let it fly. Sometimes a seller is so tired of a buyer by closing that they would rather see the buyer take a hike if they can’t close than to allow an extension. In most instances like this I’ve been involved in we’ve been able to patch together a closing even if it’s late–and we usually know earlier in the process if it’s just not going to work. But the lending world is so crazy right now it seems just as likely you could get down to the wire and only then find out that the rug’s been pulled out.

    3. Can’t tell from the facts presented who is in the wrong. This is a case where a buyer is going to want full documentation that they were in compliance with timelines throughout the process and through no fault of their own, were still unable to get financing at the 11th hour.

    I would try to patch the closing together first. If that is not possible, figure out if the buyer caused the situation through lack of timely followup. If buyer did their duty and the financing was pulled through no fault of buyer’s, seller and listing agent probably have no cause to go after earnest money.

  2. Pre-approval letter, as I mentioned in the scenario, was submitted along with the offer.

    Is it normal for a listing agent to allow the financing contingency to expire the day of closing?

  3. Tim:

    Unlike other contingencies, the financing contingency (in the unaltered form contract — Form 22A) remains open until closing. It does not “expire.” There is a widespread misperception that the time period set by paragraph 2 of Form 22A sets the expiration date for the contingency. This is mistaken. A close reading of that paragaph and paragraph 3 indicates that the stated deadline is for the buyer’s production of a “letter of loan committment,” which is obviously better than the pre-approval letter in terms of demonstrating the ability to finance the purchase. After expiration of that deadline, the seller can put the screws to the buyer and require the buyer to either waive the financing contingency or rescind the transaction. The contingency does not, however, expire by its own terms like virtually every other contingency.

    In terms of the buyer’s invocation of the financing contingency just prior to closing, the analysis begins and ends with paragraph 5. Per that paragraph, to receive the protection of the contingency, the buyer must produce a letter from the lender stating: (1) date of loan application (which must fall within the period for seeking financing as set by paragraph 1); (2) buyer had enough funds on hand (i.e. had enough cash to cover the downpayment and any closing costs); and (3) the reasons for denial of the loan. If buyer presents such a letter, then the seller would be wise to release the earnest money to the buyer. However, if buyer’s notice is deficient in any way, it may be worthwhile to dispute ownership of the earnest money. Remember that the contract has an attorney’s fees provision that would apply to any fight that devolved into litigation.

    Finally, your third question raises the issue of “good faith.” Every contract imposes on the parties a duty to act in good faith. If you could show that the buyer did not act in good faith in seeking financing, then you at least conceivably have an argument that the seller is entitled to the earnest money. However, if the buyer is able to produce the required letter from the lender, the seller would be unlikely to prevail on such an argument.

  4. Oops, sorry Tim, I misread your post. The pre-approval was the correct start, but it’s hard to say what happened at the end without more details.

    Was the loan approval extended at all, or was this date part of the original agreement with seller and buyer? Did lender communicate to agents that there were any problems (did listing agent keep in contact with buyers lender??).

    This year we will be seeing buyers with pre-approvals having difficulties obtaining financing. Sometimes it will be a new change by lenders, which is painful in the middle of a transaction, and sometimes a property will have issues, perhaps in condition, perhaps in appraisal. All agents, not just sellers agents, need to be in contact with the buyers lenders for progress reports. Documentation is the best way to be correct in choosing the path of earnest money forfeiture.

    It’s a challenging market out there, and the best agents are going to insist on buyers using a capable lender. As a listing agent, it can be very difficult to ‘counter’ an offer and ask that the buyer use a different lender — but I’ve done it before. I got a really poorly written offer on a listing last year, the agent was pretty new, and the buyer was using a friend for their lender. After talking to this loan rep friend, I felt really doubtful this transaction would close.

    After discussing this with my seller clients, we countered that the buyer could continue with this lender, but that the buyer also had to make a second loan application with a lender I recommended, and have that lender do everything but the appraisal in the first 2 weeks; we set a date for the buyer to change lenders at the end of 3 weeks if his own lender didn’t have a formal loan committment. (My lender referral agreed to do this). By the end of the second week, the buyers lender wasn’t moving forward very well (no appraiser out to property yet), and not being very responsive to phone calls or emails. By the end of the third week, we had no formal loan committment letter, so we notified buyer to complete the loan with the second lender as per our agreement. This sale did close on time, and we told the buyer that if his first lender could complete the deal in time, he certainly could close with them. That didn’t happen.
    No one likes using ‘dual lenders’, and I am not advocating for that, it’s just what we decided to do for that transaction.

    It is very frustrating when you are the sellers agent, and do not feel comfortable with the lender the buyer is using. The resistance from the buyers agent and the buyer to change this extremely important detail can be HUGE, but sometimes it’s the right thing to do, and of course, you’d better be certain as the sellers agent that you have referred a competent lender to that buyer! 🙂

  5. Craig has very well described what the new financing form states, and concisely says the 3 items needed from the lender letter that buyer must produce when seller requires either the waiver of financing or rescinding the transaction, if buyer is seeking to keep his earnest money.

    Buyer & seller could also choose to extend the loan approval date instead.

  6. If the buyer waives the financing contingency and then something happens with the loan where it falls through, then he/she would be on the hook for the earnest money, correct?

  7. Craig,

    Thanks for the insight. I think it is helpful for agents.

    It seems like transaction management would point to making certain specific events take place to protect each party.

    The idea of pre-approval letters appears to have no teeth at the time of mutual acceptance. I wonder if anyone else feels the same? I think pre-approval letters show good faith in the spirit of seriousness of a borrower, but maybe that is wishful thinking when chips are on the table.

  8. Is there a higher incidence of deals falling through at the last minute in the last six months than in past years? I can’t recall hearing too many complaints about collapsed deals several years ago, so I am just wondering if we are hearing about this now because things have changed. Are there any statistics we can look at to see how the percentage of completions on accepted offers has trended over time?

    By the way, I suspect that there isn’t a whole lot sellers can do to protect themselves from the vagaries of last minute deal failures. In down markets the sellers don’t have a lot of power, and have to take what they can get. When there is a large inventory off similarly priced properties on the market that aren’t moving, it is risky to ask for earnest money, and other guarantees, from buyers. We had just the opposite situation on the way up, where buyers were taking risks even asking to have deals subject to simple things like inspections.

  9. Leanne-

    If a borrower is really eager to purchase the home, in the cases that we see, most of the time, the parties work it out and DO extend.

    If a buyer is denied loan approval and does not work to try another lender as you mention, then it does not pass the smell test.

  10. T-Bone-

    Probably so.


    We have seen our fair share of transactions fall through due to financing. Some were resuscitated, some were not. What is different is that in aggregate a whole lot of negotiations are taking place these days where vintage ’04,’05’, ’06 deals it was virtually non-existent.

  11. Tim,

    Do you think sellers should just reject offers where the buyer is unwilling to put up substantial earnest money, or provide pre-approval letters? Even if they have had their place listed for a LONG time with no serious buyer interest? Isn’t it better to go through 2 or 3 failed deals to get a sale than to have no serious offers at all?

  12. T-Bone — yes, almost certainly, if the buyer waives the financing contingency then the buyer bears the risk (i.e. the risk of losing the earnest money) if financing fails.

    Tim — I’m not sure I agree that a buyer who does not try a lender fails the “smell test” — at least as far as that terms has a legal definition. 🙂 As noted, the buyer has a a duty of good faith. The contract itself is pretty thin on the buyer’s responsiblity to get a loan — for example, there is no indication that the buyer must seek a loan from multiple lenders if the first choice fails. So, there is no clear-cut answer in regarrds to whether or not the buyer MUST seek another lender — and thus whether the buyer loses the earnest money if he fails to do so.

  13. Tim, I’m afraid that during these times of lenders halting programs, changing guidelines and/or leaving very little times for loans to close within how the loan is currently approved…preapproval letters probably aren’t worth much.

    If I were a listing or selling agent, I would still want a preapproval letter and I would contact the lender to make sure that the program the buyers are approved for is not one that is “endangered” or if it is, can the buyers be approved for “plan b”.

    For example, I recently had to re-approve clients who were planning on using Flex 100 to Flex 97 or FHA. This means verifying additional funds, re-underwriting…etc. and if the buyers credit, debts or income have changed when re-underwriting–yikes!

  14. Craig-

    What I meant by ‘small test’ is a buyer who goes basically to the 11th hour, gets rejected for financing (who knows why), then does not try to salvage the purchase by going with another lender.


    Your question is probably best answered by an agent.

  15. # 10 from Tim, yes, the buyer really does need to take initiative and make good faith efforts to find financing, even from a different lender.

    Sometimes, it’s just smarter in the beginning to get that bad smell thrown out …

    And, Rhonda is right. We’re having last minute changes or glitches more today than in the last few years. I just had an FHA appraiser (I think she might have been a little ‘rusty’) use comps that were more than 6 months old, when there were 4 very good recent comps. That caused a 10 day delay, since she also didn’t email in her appraisal when she said she did … but we did get closed, and for the sellers as well as the buyers, the unexpected delay was stressful.

  16. # 12, Sniglet, well, no I don’t think it’s good for sellers to go thru 2 or 3 failed deals to get one that sticks.

    The data shows on the NWMLS as to the property being STI (subject to inspection) or (pending). If a property goes STI or Pending 2 or 3 different times, the future buyers may overanalyze what happened and believe there is a property condition issue, when often it was a non-qualified buyer issue.

    So, unless the buyer seems quite viable, sellers shouldn’t jump at just anything. And, if they are not getting offers, there are 3 ancient choices:
    1) take property off the market
    2) lower asking price
    3) change/upgrade condition

  17. ok, I’ll add a 4th choice:

    4) if marketing/internet photos are poor, get them corrected and write a different property description. There are some agents who just don’t seem to have a good ability to write well, some who over- describe, and some who are so clever it makes you want to gag …
    but sometimes, a property description can be re-written in a way that brings in more buyers thru that front door …

  18. It’s really a matter of full disclosure in most cases.

    2 agents called me the other day about the same buyer.

    Agent #1 “Reputable lender says they don’t qualify for a loan; so I didn’t write the offer.”

    Agent #2 “(Joe Blow from Windy City) said he could give the buyer a pre-approval letter, so Agent #1 SHOULD write that offer. That’s our JOB!”

    The offer wasn’t written.

    It’s a matter of who is taking the risk. Say buyer goes to 4 lenders who say they don’t qualify and find a 5th lender who gives them a pre-approval letter. If the buyer proceeds without involving the seller in the risk up front, then they should lose their Earnest Money if it doesn’t work out. The buyer should assume all of the risk of overlooking 4 lenders who said no if they did not disclose that fact.

    If however the buyer approaches a seller who has been on market for 155 days and says, “Hey, apparently my getting a loan is a long shot. But if you are willing to take a chance and give me my Earnest Money back if it doesn’t work out, I’m willing to foot the bill for the inspection and the appraisal costs.”

    Honesty and full disclosure will trump owner’s stuff on a moving truck only to find the sale is not happening, every time.

    That’s why there is an MLS status called “Pending BU”. Pending Back Up is the status for “shakey deal” back up offers wanted. For the status to be accurate, the seller and seller’s agent have to be “in on” the fact that the financing is shakey at best. As long as all are in the loop as to the odds of completion, then the buyer should get their Earnest Money back if that was the understanding at the time the offer was accepted by the seller.

  19. Leanne — every contract imposes a duty of good faith, but the specific contractual obligations are set by the specific contract. Here, with the Form 22A, the buyer’s exact obligations are unclear. Yes, buyer must apply for the loan within ___ days (default 5, I believe) but beyond that what must a buyer do? Apply with another lender if that application is denied? Apply with a third lender? I’m just saying there is no clear answer. Different facts — and different judges — will lead to different results.

  20. So, Craig, if the listing agent has reservations about the loan approval letter or the lender, it very much makes sense to consider requiring buyer in the very beginning to get pre-approved with a second lender … and possibly to simply require the buyer to use this lender instead. The seller needs to consider the impact of allowing a buyer to use a lender that seems shaky in the beginning …

  21. Our preapproval letters state something along the lines of “subject to changing market conditions”. I cringe when I write it, however, it’s a hard fact. Knock on wood, I have not lost a transaction in progress. But as I mentioned earlier, as a LO and as a buyer with less than 20% down or lacking other strengths, you need to be able to dance quickly if your program evaporates.

    The key is being very upfront with buyers and letting them know “yes, you’re approved RIGHT NOW for this program [and if needed] let’s look at other options in case we need to switch to plan b.”

    I’ve had listing agents contact me (where I’m not the lender) to review preapproval letters or to ask if certain programs are still available–I suppose this is another option for listing agents–run the preapproval by their preferred lender. (I think something along these lines was my first post at RCG!).

  22. I would add that Lender guidelines do change, but not too drastically on bread and butter programs that an L/O shouldn’t be able to figure it out. 30, 15 year fannie mae and freddie mac guidelines are still pretty much the same.
    You won’t see those flying around with unknown condtions too often unless it has something to
    do with viability of the borrower. Conforming stated/stated is basically gone so know new unknowns there either.
    MI insurance companies have dropped there max value to 97%LTV so a lot of lenders don’t do 100% anymore.
    Credit-risk based underwriting has changed a bit as there are more smaller credit score ranges as to help narrow
    the lenders risk and pricing is effected by that as well.
    There are also problems with “declining-markets” as defined by housing prices dropping in a certain area.
    You don’t always get the exact location when pre-approving a buyer, proposed address is usually left as TBD(to be determined).
    As an L/O I’m trying to pre-approve the buyer, not an unknown property.
    If a potential buyer or realtor with a buyer comes to me with a P&S and then says “approve me” that’s risky.
    Cart before the horse use to happen alot, but not too much anymore.
    Yes I have lost loans because I wouldn’t send out a pre-approval letter based on a phone call and the next L/O would but I slept ok that night knowing I wasn’t guessing or lying.
    Also, when someone writes up an offer in a declining market area, LTV’s change, pricing changes and credit score risk base scenarios change as well, sometimes eliminating the borrower from that property.
    It’s not neccesarily saying the borrower doesn’t qualify for that dollar range but not for that property in that area in that dollar range.

  23. Jimmy, a big difference with Freddie/Fannie guidelines is the credit score pricing. It’s quite possible that if you had a borrower who qualified at “x” rate and now their rate is higher because they’re putting less than 30% down (which is a majority of loans) and have a score below 720. What if they have a credit score of 680 and now with the price-hit, they no longer qualify?

    BTW I cringe when I have a buyer w/a P&S needing to be approved instead of meeting with me first and then buying. Risky!

  24. Exactly my point-“pre-approve” so the borrower knows what a lender(s) will allow them to afford before they go shopping.
    I think in reference to Tim’s original question, who would be at fault, I still don’t have an answer, but if the appropriate due diligence is performed up front then there is less sifting through data to find resolution.
    As others have stated a pre-approval letter isn’t worth the paper it’s written on without a financing approval letter from a lender.
    Longer upfront time to get a deal done before the P&S stage, but when clients and realtors have both in hand a the negotiating table, I think there is less turmoil overall.

  25. Who’s at fault? Thesedays it could be “market conditions”. Unless a borrower has taken actions to change what is reflected on the original loan application or damaged their credit. No one can help if a program is gone or an area is deamed declining.

  26. In these changing times I think we all agree that a buyer needs to bring a pre-approval letter with their offer to a seller.

    And, buyers please pick a competent lender, make sure your letter is professionally written, and has the necessary phone numbers on it to reach your loan rep, especially important are an after hours phone number.

    I can’t tell you how many pre-approval letters I’ve seen that give only a business number. If I’m sitting with sellers at 7:00 pm, and would like to talk to your lender rep, I’d sure like a phone number to try to reach them at.

    And, if you’re out making an offer, go ahead and call your lender rep so they know that an agent might wish to talk to them.

    Making a good first impression is more important than you realize. Don’t fall in the ridiculous trap of thinking “that seller should be darned glad to even get any offer, my letter is good enough!”.

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