Knowing The Basics Can Save You Undue Stress
The mortgages you place on your properties can be a substantial dollar amount. Knowing some of the rules and basics can be a substantial savings to your bottom line, and in your ability to sleep at night. Below is a list of 3 ideas you will want to review, compiled from the perspective of a veteran Real Estate lawyer.
1. When buying a property "subject to financing" you want to know that you have a signed, unconditional mortgage commitment from your lender before removing that financing condition. Be aware that even when you have a signed, unconditional commitment, a lender can refuse to fund your mortgage based on new information they have obtained or on a change of lender policy.
A very basic summary of mortgage law is that a lender does not have to fund your mortgage and can change their mind right up until the day of funding. In a recent case, a lender had approved the mortgage based on an ‘income based’ appraisal. Three days before closing, the lender decided they wanted a ‘direct comparison’ appraisal. This appraisal lowered the value of the property by a substantial amount. The net result was that the borrower had to come up with another $52,000 to close his deal. PLEASE NOTE, this is a rare occurrence. Once a mortgage is unconditionally committed, lenders usually follow through. However, the above principles do apply. It is always best to have a plan B
2. In two recent cases buyers removed their "subject to financing conditions"
before having an unconditional commitment from the mortgage lender. In one case the purchase price was $535,000 but the lender valued the property at $375,000 based on their appraisal. They would only lend based on the price of $375,000. This buyer lost his $15,000 deposit as he could not come up with the enormous amount of cash required in this circumstance.
In the second case, the purchase price was $285,000 and the appraisal came in at $255,000. This buyer could come up with the extra cash but it was difficult. Please remember that lenders will finance property based on the LOWER of the purchase price or the appraised value. Both these buyers made a mistake in removing their conditions before they actually had an unconditional mortgage commitment.
Further, I could have improved their situation by adding the following clause to their real estate purchase contract:
“subject to a certified appraisal confirming value of property
at the purchase price or more”
3. Many buyers are smart enough to get "pre-approved" with their lender before searching for a piece of property. The lender reviews your financial capability and decides how much money you can borrow. Let's say that you are approved to borrow $400,000. You are now equipped to go out and find property knowing that you can support a mortgage loan of up to $400,000.
PLEASE NOTE, this does not mean that, no matter what property you find, a lender will lend 400,000!
Once you find a piece of property, you bring your real estate purchase contract to the lender and apply for a specific mortgage loan on that property. Remember, the mortgage loan will be based on the lower of the purchase price or the appraised value. If you offer $480,000 for a piece of property and the lender says the property is worth $480,000 and you are applying for a conventional mortgage loan of 75% of the purchase price, the lender will lend you 75% of $480,000, which is $360,000.
They will not lend you $400,000 even though you have the financial capability of carrying a $400,000 mortgage. If the lender’s appraisal says that your $480,000 property is only worth $440,000, they will lend to you based on the appraised value of $440,000. 75% of $440,000 is $330,000. In both cases, even though you are financially approved for a $400,000 loan, a lender bases a loan on the lower of the offer price or the appraised value.
Barry McGuire, is a Real Estate lawyer who has been helping Canadians for the past 35+ years. Barry is a co-author of the Canadian best selling book 97 Tips for Canadian Real Estate Investors