You've Got a Great Offer, But Can The Buyer Consummate It? (Cash to Close and Appraised Value)

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A Purchase offer is not money in your pocket. As a matter of fact, accepting the wrong purchase offer can cost you tens of thousands of dollars if the buyers can't consummate.

I recently dealt with clients making an offer on a property where the comparable sales run in the $350,000 to $370,000 range. The ask is $380,000, which isn't outrageous in and of itself, but Seller Paid Closing Costs are so endemic that they are essentially priced into the market, at least up to a price of half a million dollars or so where first time buyers peter out. My clients initially offered a price a bit above the lower end of the comparables, and paying their own closing costs. The owners rejected that but my clients really liked the property, so we sweetened it to what was essentially a full price offer, without any appraisal contingency, and the mechanics of my clients' offer (larger than necessary down payment) were such that there wouldn't be any obstacle to getting the loan and closing the transaction unless the appraisal had come in under $330,000.

But when I called the agent on the phone to make certain they got it, she was quite snippy, implying that they have offers for tens of thousands more. Well, I don't know that she had the greatest negotiation technique in the world, because it completely turned me and my clients off of the property.

What I do know is that people offering way over asking price are not, in my experience, coming in with large down payments. In fact, when I have dealt with them, they were mostly first time buyers who were asking for seller paid closing costs, and even sometimes Down Payment Assistance back when it was still available. Basically, the deal is "We'll give you a really great price if you pay for all the ancillary costs we don't have the cash for." And these transactions result in everybody being happy and even noticeably higher commissions for the agents, as commission is paid on the full sales price.

So far, so good. But what if the appraisal is lower than the purchase price? The comparables in this instance are all between $350,000 and $370,000, as I said. Even moving up in the square footage department and adding another bedroom won't boost that much, as the property is already above average for the neighborhood - anything much more would make for a misplaced improvement.

The upshot of all of this is that the appraised value is not likely to be sufficiently high to support the loan value, unless the competing buyer has a much larger than required down payment, which they can then use the excess of to pay the amount that the sales price is over the appraisal on a dollar for dollar basis. As I've said, this isn't likely to be the case where someone is offering significantly above the asking price. People who have somehow acquired the money for more of a down payment understand that this is real money, far more than people with a minimal down payment planning on simply having higher payments.

So unless the appraiser commits fraud, the value is going to come in between $350,000 and $370,000. Let's be generous and say $370,000. Lender's evaluate value on an "LCM" or "lesser of cost or market" basis. Since the appraisal will be beneath the purchase price (if the agent's representation was truthful), the lender will treat the value as being the appraised value, which we have posited to be $370,000. Let's say the purchase price is $400,000. For a 100% Loan to Value Ratio loan, which are not available right now, the lender will only lend $370,000. For a VA loan, which will go to 103% for veterans of the armed services, the limit would be $381,100, including loan costs, and everything else including the VA funding fee - the real limit is $375,550 for the buyer's purposes. For FHA loans, the maximum loan limit would be $363,525, and that includes the 1.75 points the FHA charges - the real limit is $357,050. For conventional conforming, the effective loan limit is either 90% ($333,000) or maybe 95% ($351,500).

So, assuming a $400,000 purchase price, to make a VA loan fly, the purchaser has to have a down payment of at least $24,500, and that's assuming they're not paying any loan charges, at least not themselves. For the FHA, they would need $43,000. For conventional, maybe they could get by with $49,000, but it's more likely they would need $67,000. All of these figures are exclusive of any transaction costs the buyer is paying, of course.

If that buyer doesn't have that cash, that transaction is not going to happen. You might as well reject it to begin with, because if you accept it, all that is going to happen is that you're going to waste six weeks or more Waiting for Godot. It is my usual experience that buyers with down payments of the size indicated understand that dollars are dollars, no matter what form they are in, and are unlikely to offer prices much over asking. There are exceptions, but not many. The reason people end up paying more than asking price is because they need something special from the seller, and therefore the seller who is willing and able to give it to them can extort a higher price for that property in return, and the most common reason why buyers need these sort of concessions is because they haven't got the cash necessary for the down payment plus closing costs. Therefore, in order to induce the seller to give them the extra they need in some wise, they offer a higher official purchase price that nets the seller what they want after the givebacks. Unfortunately, if that higher purchase price is not supported by the appraisal, the buyer then has to come up with more cash - and we just posited that they don't have it. Prognosis for the transaction: not good. So perhaps it might be a good idea to require a buyer to come up with some evidence that they do in fact have the necessary cash to make the transaction happen. When I write a buyer qualification letter, that is one of the essential parts it must contain: Evidence of cash to close. When I have a listing, that's one of the things I want to see before I advise accepting an offer: Evidence of cash to close.

I should also mention that all things being equal, it is not in the seller's interests to pay buyer costs, even if they get a dollar for dollar higher price. Why? Agent commissions, title insurance, and several other costs are dependent upon the official sales price. You net more money from a $370,000 sale with no givebacks than you do from a $380,000 sale with $10,000 in givebacks. Furthermore, for the buyer, property taxes are based upon that official sales price. Making the official sales price $10,000 higher means the buyer pays more in property taxes. There is nothing wrong with the practice of givebacks, so long as it is properly disclosed to the lender and approved by them, but it can cost both the buyer and the seller significant amounts of money.

Too many agents became used to the Era of Make Believe Loans, and don't understand yet the implications of it being over. Whether you're a buyer or a seller, you want to consult a loan officer on whether or not the loan for a given purchase offer is likely to be able to be done. Of course, if your agent is a good loan officer, you're already ahead of this game.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on July 3, 2013 9:00 AM.

Mortgage Fraud Is Still Happening - What To Do About It was the previous entry in this blog.

Some Risks of Lender Owned Properties (REO) is the next entry in this blog.

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