Can a Lender Legally Stop Loan Funding After Signing?

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That question brought someone to the site. The answer is "Yes, they can". As a matter of fact, just because they have you sign those documents does not in any way obligate that lender to actually fund your loan.

There are two sections of conditions on every loan commitment. The loan commitment is what the underwriter writes up when the loan is approved. The first section is called "Prior to Docs", meaning before the final loan documents the customer signs at closing are generated. These should be all the stuff that's substantive in nature, that governs whether or not you qualify. Unfortunately, that is often not the case. The second section is called "prior to funding," or "funding conditions." This should be limited to simple procedural stuff like a final updated payoff demand, final verification of employment (they call and make sure you still work there), etcetera. However, more and more, conditions that more properly belong in "prior to docs" section are being moved to "prior to funding."

Why do they do this? Well, once you sign those documents you are more heavily committed to them. Once you sign, and the Right of Rescission (if any) expires, you are stuck with that lender. You no longer have the right to call it off. If you go elsewhere, to another lender, because they are taking too long, they can fund your loan and force you to live by the terms of the documents you signed. Bad business all around, and you're going to be dealing with two sets of high powered lawyers that the contracts you signed basically obligate you to pay for - but they work for the two different lenders!

One fact that many people don't understand is that it's a rare loan application which is rejected completely. I don't remember when I've ever had a loan application outright rejected. Of course, being a good loan officer, I'm going to be as careful as possible that the people will qualify before I submit their loan package, but this is far from universal. Many loan officers routinely tell people about loans and programs that they have no prayer of qualifying for, but there sure are some great rates attached, for all the good they will do you. Then the loan gets rejected but they sit on the rejection while they work the loan they had in mind for you all along, and come back and say, "This is the best I could do" at closing time, and an extremely high percentage of people will sign on the dotted line because they think they have no choice.

What happens much more frequently is that the loan gets approved, and the underwriter writes a loan commitment, but with conditions that cannot be met in this particular instance. The borrowers need to prove more income than they make is probably the classic example, but these "killer conditions" occur in every area of loan underwriting. More often than not, the loan officer is not really surprised by these, and most often, they won't ever tell you about them if they can avoid it. Why? Because that gives you a "heads up" that you're not going to get the loan you thought you were, and at a time when it's still very possible for you do go loan shopping elsewhere.

A good loan officer - both competent and ethical - will not tell you about a loan they don't think you're going to qualify for. My ambition is always to have the list of conditions, both "prior to docs" and "prior to funding", to be as short and unsurprising as I can possibly make it. This saves work and it saves time. Remember, every time that underwriter touches the file they can add more conditions, and they can also discover something that causes them to essentially reject the loan, by adding conditions the consumers in question cannot meet. If I can submit a file and the underwriter writes a commitment with only the standard and unavoidable prior to funding conditions, I am much happier because now I can request documents, have them signed, and get this loan done. You get this kind of commitment by sending all of the documentation they need in every loan all at once, in the beginning, but only that documentation. It's not necessarily a sign of incompetence if the underwriter puts some other conditions on it - probably somewhere close to half of my commitments have some condition the underwriter took it into their heads to require in this instance. Like any good loan officer, I avoid arguments with an underwriter if I can, so when they give me a condition I didn't anticipate, I figure out what I need to satisfy it and whether I can get it. But you learn when extra documentation will be required.

Since this was originally written, underwriting has gotten completely paranoid. I have had clients in the lender's ideal situation - high credit scores, low debt ratio, steady income, plenty of equity - given the underwriter runaround. Actually, this is basically every client. It has to do with investor paranoia, as the lenders are doing everything they can - not merely everything they reasonably should to persuade the investors these loans are not going to lose money and are therefore worth paying a higher price for. But in my experience the additional conditions seem to be falling almost entirely on the "prior to documents" (before you sign) side, rather than "prior to funding"

Many loans, particularly sub-prime, are done completely in the reverse fashion. The loan officer submits a bare application, without supporting documentation, and waits for the conditions, and boy do they get a blortload of conditions. Not too long ago I helped an experienced real estate agent in my office with his first loan. He insisted on doing it "the easy way," by which he thought he meant, "The lazy way," but he really meant, "The hard, stupid way." Despite my warning, he submitted a bare application to the lender and got seven pages of conditions, which were added to as time went by and he submitted documentation piecemeal. Took him two months and four times the work of just taking another day and submitting a complete loan package in the first place. If he had done that, the loan probably would have been finished in two and a half weeks. Some of the conditions were for stuff I had never encountered before. What was going on, of course, was that the underwriter had gotten it into his head that this was probably a dangerous loan to approve, and he wanted to be extra careful on the approval.

So what can the average person do to safeguard themselves against this happening? Well, you can't - not completely. The underwriter can always add conditions, and so can the funder. Even if the loan gets funded, they can pull the money back right up until the moment that trust deed gets recorded with the county. That's just the way it is. What you can do is ask for copies of the loan commitment, and of the outstanding conditions, those that have yet to be met. Refusal on the part of a loan officer to provide this is always a bad sign. Ditto the inability. I definitely wouldn't sign the loan papers without a copy of the outstanding conditions in my possession, and it may be smart to ask for copies of the conditions at several points in your loan. Yes, they can be faked, pretty easily, but then they are ammunition in your lawsuit if something goes wrong, and most of the bad loan officers are too lazy to fake them anyway. Before you even apply, you can ask questions about necessary income, what the program guidelines for debt to income and loan to value ratio are, etcetera. Much of the stuff in my article Questions You Should Ask Prospective Loan Providers is aimed at defusing that kind of situation. Remember, at sign up you have all the power, but at closing, the lender has all the power. They have the loan, and nobody else does. Many times, the loan they deliver at closing will have nothing in common with the loan that got you to sign up. I used to advise people to sign up for a back up loan, but even I can't do them anymore because of the high cost failing to deliver a locked loan carries.

Loan officers have people sign loan documents every day that there is no hope of actually funding a loan on. It doesn't make sense to me, but they do it, mostly because they are afraid if they break down and tell you they can't fund this loan, you will go elsewhere and they won't get paid. Signing loan documents more strongly commits borrowers to this loan, and as long as they keep trying, there's always the possibility that they will get paid. I have talked with people that were strung along for three months before they finally gave up and realized that this loan was not going to happen.

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About this Entry

This page contains a single entry by Dan Melson published on May 27, 2014 7:00 AM.

First Time Home Buyer Assistance Programs: Locally Based was the previous entry in this blog.

Buyers Who Don't Want A Buyer's Agent is the next entry in this blog.

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