- Agreements Of Sale: Mortgage Contingencies Are Not Simple
- September 11, 2003 | Author: Harris Ominsky
- Law Firm: Blank Rome LLP - Philadelphia Office
When does the buyer's deposit "go hard" under a standard residential agreement of sale? "Going hard" is a somewhat flippant and inexact shorthand for the date when the conditions of purchase are met and buyers will forfeit their deposit to the seller if they don't close on the purchase.
Buyers frequently condition their obligations to purchase a property on completing a satisfactory inspection and receiving mortgage financing. When those conditions are met, sellers can rest more easily because they know the buyers have then committed their deposit. If the buyers do not close, they stand to lose the deposit as liquidated damages under most agreements.
This is a crucial point for the sellers because they then will frequently commit themselves to move out of their house. They may buy or rent a new home, and even throw out their grown kids' nature projects, high school texts and comic books that had been accumulating in the attic.
The answer to when a deposit goes hard depends, of course, on the type of agreement the parties sign. Generally, Pennsylvania brokers will urge the use of a "Standard Agreement of Real Estate" which has been recommended and approved for the members of the Pennsylvania Association of Realtors (PAR). That form is devised to accommodate various alternatives and to make it relatively easy for parties to fill in the blank spaces and check the blocks. One of the series of blocks that must be checked come under the category of the "mortgage contingency". Occasionally buyers will not need a mortgage contingency because they have been pre-approved for a mortgage and they know this will give them an advantage when competing with other buyers for the property, or because they have a rich family or several hundred thousand dollars lying around. But, most buyers will elect to condition their purchase on obtaining a mortgage.
With the guidance and advice of experienced brokers or attorneys, an overwhelming majority of mortgage contingencies are completed and the purchases are closed smoothly. The story then ends happily. Unfortunately, every once in a while something unexpected happens. The sellers change their mind. The buyers change their mind. Or the buyers fail to get the needed mortgage. That's when the mortgage-contingency clause is tested -- and sometimes found wanting.
When the blank spaces are filled in, the standard mortgage-contingency clause contains predictable information. It provides that the sale is contingent upon the buyer "obtaining mortgage financing" in a minimum stated amount for a minimum stated term, at an interest rate not to exceed a certain rate; and it also includes other requirements about whether the mortgage will be conventional or otherwise, and specifies maximum discount points and other fees that may be charged by the lender.
The form also requires the buyer to make a completed written mortgage application to a responsible mortgage lending institution within ten days of signing the agreement, and it requires delivery of the mortgage commitment to the seller or the seller's broker by a specified date.
Failure of Financing
All of that is what one would expect. What is sometimes not expected or reviewed in the printed form is what happens if a loan commitment is not received by the mortgage commitment date. In many commercial deals, when that date passes without a written mortgage commitment, the deal is off. The agreement is automatically terminated and the deposit must be returned to the buyer. Sometimes, if the buyer fails by that date to notify the seller that it has not received a commitment, the buyer is committed to buy anyway and the deposit then goes hard.
That's not the way the PAR agreement treats a failure to meet the mortgage commitment deadline. That form says that the mortgage commitment date is automatically extended until either the seller or buyer terminate the agreement. Therefore, if neither party acts to terminate the agreement, the deposit will never go hard! On the scheduled closing date, it is theoretically possible that the buyers will tell the seller that they don't have their mortgage financing and then require a return of the deposit. That could stick the seller with a new house, two mortgages to pay -- and possibly a cleaned out attic.
The agreement also covers what happens if a commitment is issued but it is either "not valid until the date of settlement," "conditioned upon the sale and settlement of any other property," or "contains any other condition" not specified in the agreement of sale. Then, the commitment is treated as though it never happened and either party can terminate the agreement, thereby triggering a return of the deposit to the buyer.
One of the lessons from all of this is that sellers cannot assume that the deposit has gone hard once the mortgage commitment date has passed. Sellers and their representatives must check that there is not only a written commitment, but also that the commitment does not contain any unwanted conditions.
Even when a commitment is issued which meets all of the required terms, the seller may not be home free. If the buyer cannot close on the loan because of failure of asset and salary verification, divorce, a casualty, or even default by the lender, the buyer may still be entitled to a return of the deposit at the last minute. It's a rather subtle issue, but the PAR agreement makes the sale contingent upon the buyer obtaining mortgage "financing," not a mortgage "commitment." Therefore, unlike language in some commercial agreements, in effect, that language places the risk of non-funding on the seller, and not the buyer.
Failure of Buyer
These are all the more common consequences of the PAR mortgage-contingency provision. However, the consequences become more complex when buyers vary from the standard path in applying for a mortgage. For example, what happens if buyers do not complete a mortgage application within ten days, as required, or they request a mortgage on different terms than described in the agreement? Does that merely give the seller a right to terminate the agreement, or does it also give the seller the right to retain the deposit if the buyer doesn't complete the closing?
On the face of the agreement it appears that failure to apply for and cooperate in the processing of a loan application that results in failure to obtain the commitment, gives the seller the right to retain the deposit. Paragraph 27(C)) of PAR agreement states that if the buyer fails "to fulfill or perform any other terms or conditions of this agreement," then the seller may retain the deposit.
What happens if buyers apply for a mortgage on different terms than specified in the contingency clause? For example, suppose buyers apply for a mortgage in a higher amount - - or a lower amount? Or, suppose buyers request a mortgage that is conditioned on the sale of their present home?
Suppose buyers reject the commitment because they don't like some of the less obvious terms, such as required escrows or use of insurance proceeds?
These cases will have to be dealt with on a case-by-case basis, considering the discussions between the parties, the background of the deal, the other terms in the agreement and the buyers' motivation in varying from the specified mortgage terms. However, generally, buyers take a risk in unreasonably rejecting a commitment, because they may have breached the agreement; and in the case where they have applied for a smaller mortgage, they may have waived their right to obtain the larger amount set forth in the contingency clause. Courts will usually hold the buyer to a "good faith effort" to obtain financing, and where buyers "profile" a mortgage commitment in such a way to make it unlikely that they will succeed in obtaining the financing, they will probably forfeit the deposit. See Scherer v. Nase, 591 A.2d 1086 (Pa. Super. 1991); Friedman on Contracts & Conveyances of Real Property, Section 1.5 (1998).
It is not customary for sellers or their brokers to request buyers to confirm in writing that they are satisfied with their mortgage commitment, or that they have waived the contingency. But if sellers want the deposit to go hard, they would be well advised to take that step.
Also, it is important for lawyers and real estate professionals to realize that standard form clauses, like standard dress sizes, may sometimes need alterations.