By Alexandra Swann, Vice-Chair – CCAR’s REALTOR®/Lender Committee
On February 12, TREC introduced a new form to deal with the issue of buyer’s right to terminate—or ability to waive the right to terminate—when an appraisal comes in low. In rapidly appreciating markets, such as ours, appraisals can’t always keep up with housing prices. In multiple-offer situations, buyers often try to distinguish themselves by agreeing to pay over the appraised value of the house. For a while, we saw a lot of contracts with verbiage in the Special Provisions section of the contract essentially stating that the buyer agreed to pay a certain dollar amount over the appraised value. TREC has disallowed that practice, but to deal with the issue they have introduced TREC form 49.0 which clearly lays out the buyer’s rights and options for termination due to a low appraisal.
First, the new form is to be used in connection with the Third-Party Financing Addendum Paragraph B2. This is important because loan terms change when property appraisals come in low because the mortgage loan is based on the LESSER of the sales price or the appraisal. Form 49.0 amends the right to terminate provided in B2 as follows.
The borrower’s right to terminate, if the property does not appraise and the lender reduces the loan amount, is completely waived. For example, if the buyer signs a contract for a sales price of $300,000 and the house appraises for only $280,000, the buyer is still committed to purchase the home for $300,000. If the original loan were based off 80% loan-to-value, the original minimum down payment would have been 20% of $300,000 for a total of $60,000. However, since the appraisal is based on the LESSER of the appraised value or the sales price, the buyer would now have a minimum down payment of 20% of the $280,000 (appraised value) which equals $56,000. In addition, the buyer would need to bring the $20,000 difference to closing, making the total minimum down payment $76,000.
The borrower’s right to terminate, if the property does not appraise and the lender reduces the loan amount, is partially waived. The buyer can designate an amount that he/she will accept for the appraised value and if the appraisal comes in for that amount or higher, the right to terminate, based on the appraisal, is waived. For example, the buyer signs a contract for $300,000, but in Option 2 he/she agrees to waive the right to terminate if the house appraises for $290,000 or above. If the home appraises for less than $290,000 he/she can terminate. If the buyer were applying for 80% loan-to-value financing, based off a sales price of $300,000, the minimum down payment would be $60,000. If the home appraised for $290,000 the buyer would need to put down $58,000 (20% of the appraised value) plus the $10,000 shortage in value. The buyer could also opt to change the financing to say 10% down. In that case the minimum down payment would be $29,000 (10% of appraised value). The buyer would still need to bring the additional $10,000 to closing so the total minimum down payment now becomes $39,000.
The borrower is granted the right to terminate if the appraisal comes in below sales price. This doesn’t require the buyer to terminate, but allows the buyer to terminate or negotiate. The buyer could still pay the difference, seller could lower the sales price, or they could agree to meet somewhere in between.
For many buyers who are selling a home and moving up, paying an additional $20,000 or $30,000 to secure the right home may be feasible and well worth the extra cash out of pocket. For other buyers, especially first-time buyers, even an extra $2,000 or $3,000 may be a deal-killer. The secret to successfully navigating these various options is going to include candid discussions about financing with your buyer’s lender.
First, buyers need to understand that they may have to bring in extra cash, should the home not appraise for the sales price. They need to be prepared to provide their loan originator with proof of all cash assets. Realtors will need to be prepared to ask the buyer’s loan originator if he/she can afford to bring in extra cash to closing and if so, how much.
Before committing a buyer to an appraised value in Option 2, the REALTOR® will need to make sure that the buyer has a fee worksheet from the loan originator detailing how much cash is needed to close if the appraisal comes in low. Seeing total figures in writing, including closing costs, helps buyers understand more clearly what is required of them. A REALTOR® will also want to make sure that the loan originator has verified enough cash to close from assets that are available and liquid. This is especially critical if the buyer is purchasing an investment property. Investors will be required to document their funds needed for closing and, in addition, will need to document reserve funds. Any changes to the sales price or appraised value may require recalculation of the reserves to make sure that the buyer can still qualify.
Second, buyers need to understand ALL of their financing options. A buyer who is determined to put 20% down to avoid MI may need to rethink that strategy. To win a bid on the right house in a hot neighborhood, he/she may have to be willing to pay more than the appraised value, which simply may not leave enough cash for a 20% down payment. This is not terrible news; MI rates for well-qualified conventional buyers with high credit scores are extremely affordable now. The buyer needs to work with the loan originator to review options with MI and a lower down payment. With a little education, the buyer may find that an extra $50 a month in MI is all it takes to make the right home, in the right neighborhood, a reality.
The Texas Association of REALTOR® has an excellent “online townhall” webinar prepared by an attorney to help you understand and complete FORM 49.0 and all the new TREC forms. You can access it here.
For questions about how Option 2 of Form 49.0 affects your buyer’s loan, and for all other lending questions, email CCAR’s REALTOR®/Lender Committee at email@example.com.