That’s an odd phrase, isn’t it? Apparently, it derives from colonial America times, if the internet can be trusted.
Let me be a little clearer and skip the ambiguous phrases of murky origin and just get down to brass tacks.
Today we’re going to talk about what happens when someone buys a home and the appraisal from the lender comes in at less than what they agreed to pay.
Let’s do a quick review of the basics.
A buyer submits an offer for a property at a price they are willing to pay.
By definition, this is now market value, as the home went up for sale (on “the market”) and a buyer offered a purchase price that the seller accepted.
Boom, market value established.
If the buyer has all the money for the property, then that’s it.
Most buyers have a mortgage of some amount though, and this is where things get a bit more complicated.
A lender (be it a bank, credit union, private lender or your Aunt Sally) makes the decision to lend to you based on how much you make, how much you owe and your past record of borrowing responsibility.
My clients go through this process before we get too far along in the purchase journey. By providing job documentation, bank information and submitting to a credit history review, you are pre-approved for a certain amount at a certain interest rate.
A pre-approval can be looked at as the lender saying to you “OK, I’m comfortable loaning you this much money based on your situation.”
When a prospective buyer finds the home that fits their needs and this budget, we negotiate the best price and terms possible and buy the home. If we can, it is conditional upon financing approval.
While the market in the last year has made it very challenging to buy a home with any conditions, the reason we want financing approval is because the buyer needs to turn their pre-approval in general terms into approval of a specific property.
Here’s an example.
My client buys a home listed at $729,900 for $800,000 in multiple offers. While we would have preferred to have a financing condition in place, with other offers in play that had no conditions, my client made the decision to remove the financing condition. He had his pre-approval up to $900K in place and had a downpayment of $160,000 ready. This meant that he had 20% of the purchase price and wouldn’t need to pay CMHC fees.
Though my client is willing to pay $800K for the property and has been pre-approved for up to $900K in a general sense (based on his income, debt levels and credit history), the lender must be comfortable that the property is worth that $800K. In essence, they need to be confident that when it comes time to sell the property and recover their loaned amount (the outstanding mortgage due), they will be able to get their full amount back.
The lender sends in the appraiser and in a few days, comes back with some bad news.
The property that my client has bought firm for $800K is appraised at $750K, a shortfall of $50K.
My client expected the purchase would like this.
Purchase price $800K
Mortgage $640K (80% of $800K)
After the appraisal comes in lower than the purchase price, the lender says to my client, we were willing to loan 80% of the purchase price to you, with you providing a 20% downpayment. We are still willing to loan you 80% of the appraised value, but you need to come up with the shortfall.
The purchase now looks like this.
Purchase price $800K
Mortgage $600K (80% of $750K)
As a result of the appraisal value, my client needs to find an extra $40K in order to close on the deal. He may be able to find another lender to offer that $40K at a higher interest rate (as second mortgages are second in line after the primary lender for repayment and are therefore riskier) but it will depend on what the changed interest rate does to his debt servicing ratio. If he was at his limit then finding another lender may be difficult or impossible.
When a buyer has made a firm purchase of a property and runs into financing problems, it is possible that the deal won’t close. If the buyer can’t get the money to close on the closing date, then the seller won’t hand over the keys.
To be clear, the buyer has a legal obligation to close on the deal as per the agreed upon terms. A legal obligation isn’t the same as actually having the money though.
The deposit that was provided at or shortly after the purchase date (when the price was agreed upon and the papers signed) is held by the seller’s real estate brokerage. If the buyer cannot close on the deal, then the seller has the option of showing damages and keeping some or all of the deposit that the buyer provided.
Determining damages can be complex and lawyers will be involved on both sides to determine if and how much of the deposit can be kept by the seller as a result of the buyer failing to close as they are legally obligated to do.
It’s a messy situation and one that should be avoided at all costs. It truly is something that neither side wants, as both the buyer and seller wanted to do the transaction and agreed upon terms that one side ended up not being able to complete.
Here’s how I work for my clients to avoid a situation like this.
When I work with buyers, we discuss the repercussions of a lower appraisal, change in interest rates and other factors. If we are in a situation where we cannot have a financing condition, we have done our work beforehand to know the consequences of a lower appraisal and have the ability to make up the shortfall if need be. I leverage this information with the seller and their agent, letting them know that we are a solid purchaser who can close even if the appraisal value is lower. I’ve used this to get a seller to choose my client over a higher offer price because the seller was more confident we would close without an issue.
On the selling side, I ask questions of the buyer and their agent to get at their situation with regards to financing. I want to know downpayment amount available, income and type of work and their pre-approval status. This is true regardless of if the buyer doesn’t include a financing condition. While my seller may have recourse if the deal doesn’t close, my goal is to make sure that from offer to close we have a smooth process.
If you or someone you like is considering buying or selling, make sure you work with a Realtor that works to make sure the deal actually closes. From the day of negotiations to the day the keys are transferred, I’d love to be responsible for what comes next.
Give each person, especially as he grows old, the chance to set up a workplace of his own, within or very near his home. Make it a place that can grow slowly, perhaps in the beginning sustaining a weekend hobby and gradually becoming a complete, productive, and comfortable workshop.
This lesson is a bit more theoretical than some of the other lessons I’ve highlighted. It speaks to the need to have space within a home for activities that can be both a source of enjoyment as well as income. In many cases, that translates into some sort of home office where the resident can continue the work they enjoy and are skilled at to earn some income. Bookkeeper, writer, graphic designer, journalist, administrator – all of these things can be done from home to some extent.
There is a tendency in our society to differentiate between work and fun, between employment and retirement. This ignores the fact that in many cases, the worker has done the job for many years not only for income, but because they are skilled at and enjoy the work. By setting aside a space in the home for continuation of this activity, whether for pay or for enjoyment, the resident has a higher quality of life.