By Bob Baker, Keller Williams Realty on behalf of CCAR’s REALTOR®/Lender Committee
This article addresses financing in a residential transaction, with special attention given to FHA/VA financing.
A key concept in a transaction relates to the money that makes up the sales price. A buyer may say, "I will pay you $400,000 cash for your house." The thought of the buyer is that there is something magical about this being a cash offer. However, a knowledgeable listing agent and seller may realize that, at closing, it is all cash to the seller anyway. So, the question is: "What is the source of the $400,000 cash you are offering me?"
This is where proof of funds comes in. It is valuable for agents to understand that a buyer with approved financing, including underwriting, is essentially making a cash equivalent offer, subject only to property approval. In fact, this buyer may be a better buyer, since there has been a more detailed vetting of the buyer by a lender. The "proof of funds" concept is very inconsistent, with no standard documents and often only minimal financial information offered by the buyer to the seller.
As the buyer provides information to the seller on the source of funds, there is not only information, but also disclosure of potential conditions involved. The seller is clearly in a better position to make an informed decision as to the quality of a specific buyer.
There are two primary TREC promulgated forms that can be used in the transaction, which provide information on the financing, conditions that may be present with specific types of financing, and contingencies associated with certain rights of the buyer.
The first document is the Third Party Financing Addendum, TREC 40-9/TXR 1901. This document has four primary paragraphs with important information on type of financing, conditions and contingencies.
- Paragraph 1 sets forth the type of financing, which will relate to the conditions and contingencies associated with that type of financing. For example, if the parties enter into a contract with lA checked, which is conventional financing, and during the transaction the buyer changes to FHA financing (without a mutual amendment to the contract by both parties), then the buyer does not have the benefit of any of the conditions or contingencies associated with FHA financing since that is not the contract entered into by the parties.
- FHA or VA financing is addressed in the 3rd Party Financing addendum in paragraphs 1C or 1D, and further in paragraph 4 of the addendum. The loan amount and loan terms in paragraphs lC or 1D relate to the buyer approval in 2A of the addendum. If the buyer determines or believes, based on the information from their lender, that they cannot obtain buyer approval, then within the timeline of 2A the buyer can terminate the contract. This contingency is the same if this were a conventional loan with loan and terms stated in lA.
- Paragraph 2B, Property Approval, has similar requirements that the property meet the lender's underwriting requirements. The timeline of the contingency for a conventional loan ends 3 days prior to closing, but extends to closing for FHA/VA financing.
The second TREC document addresses the most common element parties (and agents) tend to pay attention to, the appraisal. On a conventional loan, the TREC addendum Concerning Right to Terminate due to lender's appraisal, can address the appraisal issue. However, this addendum cannot be used for FHA/VA financing. The issue for an FHA/VA buyer is how to address the appraisal issue.
The most common strategy in our marketplace is inserting language in Special Provisions of the offer, in which the buyer waives the appraisal contingency either entirely or partially. This would require attorney prepared language, as this would be treated as more than a mere business detail. Virtually all the good attorneys who are willing to draft this language are honest in stating that, if in the transaction a conflict between this language and the FHA/VA rules were to develop, then no one knows which will prevail. To my knowledge, we have not had a test case in Texas yet, but are confident there will be one, as this strategy is becoming more prevalent. We are also clear we don't want to be the test case.
The challenge for the agent in an FHA/VA transaction is to provide the client with information on their options without crossing the line and giving legal advice. The agent needs to be sure their seller client understands the risk of this strategy and makes an informed decision on its use in an offer they otherwise want to accept.
Clearly, the end goal of the buyer is to make an offer that is acceptable to the seller and yet establishes the conditions the buyer also finds acceptable.
There tends to be a hierarchy of what agents and sellers consider to be attractive offers. This tends to start with cash offers, then conventional with significant down payments, and then, if necessary, other types of financing if the offer is otherwise a really good offer. These other types are typically FHA and VA. Educating sellers and agents on the true pros and cons of these different sources of funds is important, so a seller can understand how much importance they should be placing on financing as one of many elements in the offer.
My experience is a well-qualified FHA/VA buyer may be a better buyer than a conventional buyer with a large down payment, which that buyer may have to do in order to qualify for a loan. Of course, an important element of a VA loan is the factor of a veteran buyer who doesn't have to use the VA loan, but wants to use a well-earned benefit.