The Third Party Financing Addendum for Credit Approval
The Third Party Financing Addendum has been updated since this post was written, see the current version of the form in our post about the Third Party Financing Addendum for more information about the changes.
Since our series on the listing agreement proved so successful, we thought we’d take a look at some more real estate contract forms over the coming weeks. Today, we’ll be looking at the Third Party Financing Addendum for Credit Approval. This addendum is required as part of a purchase contract when it involves a loan. The form outlines what the buyer will be seeking in terms of financing and lays out some important timelines and negotiating points. The cloud scanning tools are really crucial to secure information.
The preamble to the Third Party Financing Addendum for Credit Approval sets the tone for financing. It states that the buyer will promptly apply for financing as described on the addendum and provide all information to the lender needed to make the loan happen. It defines “credit approval” as the point at which 1) the terms of the loan as described on the addendum are available (ie, the buyer can get a loan with those terms) and 2) the lender is willing to approve the buyer for such a loan after looking at the buyer’s income, assets, and credit.
If the buyer cannot obtain credit approval, they must give notice within the time period entered into the blank space in this paragraph. This timeframe is very important in the contract and is negotiable. It is counted in days – so if a buyer can not get credit approval within X days and notifies the seller within that number of days, the buyer has a way out of the contract and their earnest money will be returned to them. This is one of several ways a buyer may exit a contract without penalty.
The last two sentences in this paragraph are in bold for a reason, they are crucial to the understanding of the paragraph and not paying attention to them could cost a buyer big time. They read as follows:
If Buyer does not give such notice within the time required, this contract will no longer be subject to Credit Approval. Time is of the essence for this paragraph and strict compliance with the time for performance is required.
Basically, if the buyer doesn’t notify the seller that they cannot obtain financing, they waive the credit approval requirement and now are not able to get out of the contract for this reason. This can be devastating to a buyer if they miss this timeline and cannot get financing as they can still legally be on the hook to buy the house. This is where lawsuits can occur quickly.
A buyer will want the timeframe to be as long as possible, so that they can retain a way out of the contract. A seller will want it as short as possible to remove the possibility of financing not happening at the very end of the closing. Depending on which party you are to the contract, you’ll want to negotiate the most favorable terms.
Following this paragraph is a “note” that clears up the fact that credit approval does not include approval of lender’s underwriting requirements.
The next five sections (A through E) cover the different types of loans.
A. Conventional Financing
This section covers conventional financing and has a section for both a first and second mortgage. As with any blank on a contract, these sections are negotiable. Each paragraph lays out the terms of the loan; the amount borrowed, how long the long will be (30 year, 15 year, etc.), the interest rate (a not to exceed amount), how many years that interest rate will be for (this can vary if it is an adjustable rate mortgage), and what the origination charges will be. Origination charges are the amount the lender charges to make the loan and it is expressed as a percentage of the loan amount (ie, if you’re borrowing $500,000 and have a 1% origination charge inserted, the lender can not charge you more than $5,000 – if they did, you would potentially have a way out of the contract as the lender could not meet those requirements as laid out in the Third Party Financing Addendum).
B. Texas Veterans Loan
Probably the simplest of the paragraphs as it only requires the amount of the loan and how many years the loan in for. The Texas Veterans Land Board determines the interest rate.
C. FHA Insured Financing
This section, like the others gets the terms of the loan spelled out and includes a section for what type of FHA loan will be sought out. There are several types of FHA loans, the two most common being a 203(b), which is a pretty straightforward loan, and the 203(k), which is known as a renovation loan.
The FHA section of the Third Party Financing Addendum for Credit Approval does have extra verbiage however, that is very important. FHA requires that a house must appraise for the value of the purchase price in the contract or the buyer may terminate the contract with no penalty and receive their earnest money back. The buyer may proceed with the purchase, but they will have to make up the difference between the appraised value and the contract price. It is very important to note this appraisal requirement in a contract as if the home doesn’t appraise and there is an FHA loan involved, typically, the deal with fall apart (most buyers don’t have the money laying around to make up the difference and most sellers don’t want to sell for less).
It’s important to note that the blank in this paragraph requires the purchase price (as written into the contract) and not the loan amount. We’ve been seeing a lot of contracts lately with just the loan amount in that section. This means that the home only has to appraise for the loan amount and not the agreed upon sales price.
D. VA Guaranteed Financing
Again, the section starts off with determining the terms of the loan that the buyer is seeking. It also has a notice similar to the FHA financing section about the requirement of the home appraising for the purchase price, with the protection of the buyer receiving their earnest money back if it does not appraise for that price or being able to pay the difference themselves.
E. USDA Guaranteed Financing
Similar to the other paragraphs, with the loan terms being set forth.
It should be noted that these loan terms (in any of the sections) are what the buyer is attempting to get and they are negotiable. From a buyer’s perspective, it pays to have unrealistic numbers in these sections, as it would give them an easy out (although a sharp listing agent would catch that immediately). From a seller’s perspective, the loan terms should be reasonably obtainable, so that the buyer can get the loan, and therefore would lack the potential exit and return of earnest money.
Although only a two page document, the Third Party Financing Addendum for Credit Approval is a very powerful tool. In multiple offer situations, the terms a buyer puts on this form could easily make or break a deal. With it, the buyer can find a way to terminate the contract and keep their earnest money if they cannot find credit approval under the terms they’ve written into the form, so it’s important for sellers to pay attention to the numbers, particularly the number of days the buyer has to obtain credit approval as written in the first paragraph. As time is of the essence in real estate contracts, it is important to know your timelines and stay on top of all parties to make sure everyone is meeting their obligations. Your agent will help you keep these deadlines, but you should be prepared and ready to meet them to keep things running smoothly.
image courtesy of Rob Lee
Can you explain the difference between paragraph 4A of the contract vs the Third party Financing addendum?
Good question mnancytx…
In the simplest of terms, Paragraph 4A is used to say whether or not you will be using financing, while the Third Party Financing Addendum
Emilie Schmid says
What is the typical amount of days entered into this form? 30 days?
Matt Stigliano says
The number of days to obtain financing approval can vary widely…particularly depending on which side you represent (or are) – buyer or seller. This number is negotiable and fluctuates from deal to deal. It should reflect a true time the buyer needs to get full credit approval, so it’s always a good idea to speak with the lender, so that the buyer is not asking for less than is required. The buyer would want that time frame to be as long as possible to avoid any unseen pitfalls and provide them with an “out” of the contract should it be necessary. The seller on the other hand would want this time period to be as short as possible, so that they are not waiting with their home off the market for long periods of time, only to find that the buyer did not get their credit approval and is able to terminate the contract within that period.
It is recommended that you speak with your agent and lender in order to determine how much time is needed as a buyer or how much time you are willing to accept as a seller.
Sue Axtell says
Can you tell me what it means if the number of days to get financing is left blank? Since neither a 0 or any other number is entered here, does that give the buyer unlimited time to get the loan approved? In other words, does this work for or against the buyer if it is left blank? Thanks for any help.
Okay, so one correctly calculate the number of days as to when the last day at midnight the buyer must give written notice to terminate or request an extension?
For example, if the effective date of a contract is 12/2, then when is the last day to give notice? Is it not calculated just as one does for the option period? In this case would it not be 1/1? Day 1 is 12/3 and day 30 is 1/1
Matt Stigliano says
Yes. In your example, 12/2 would be the end of day 1 and January 1st would be the 30th day. I always think of it as the execution date is day zero. Of course the timeline in the Option Period has changed somewhat (it now ends at 5pm local time to the property, as opposed to 11:59pm), but that’s in an upcoming post.
In a recent contract we have to buy a house, the terms written into the contract state: “30 year mtg, rate no higher than 5%.” What if I want to obtain a 10/1 year-arm? Is this a deal breaker? Would I have to notify them that I got an ARM instead of a conventional 30 year mortgage? Or is this not a huge deal as I have been approved for the mortgage, etc. I just can’t see why the seller cares what kind of mortgage I obtain. Once they sell me the house, they’re off the hook, right?
Thanks for any advice.
Matt Stigliano says
The reason for the definition of the loan terms in the Third Party Financing Addendum is to give the buyer the opportunity to define the base loan terms that they are seeking and then, if they cannot get a loan with those terms, then they can terminate the contract (as long as they do so within the financing approval period). In your example, if the lender came back and said they could only give you a loan at 10% interest, you would have a way out of the contract. If you don’t mind and want to continue anyway, you can, it just gives that option. It protects buyers from wanting to buy a house and then finding out that the loan terms being offered are way out of their league.
As a listing agent, we want these numbers to be high – if a buyer in today’s market wrote they needed a loan at 10%, they’re probably going to be able to get something to beat that and have no way out of the contract for financing. As a buyer, you want those numbers to be as low as possible – if you have said you were looking for a loan at 1%, chances are no lender can give that to you, so you wouldn’t be approved for a loan, so you would have a way out of the contract during the financing approval period. Of course, a good listing agent would spot that and would advise their clients that that isn’t the best idea for them.
Overall the seller shouldn’t care what kind of terms you obtain, but they should care what you’re trying to get. If you’re searching for the impossible, then your chances of not being approved increase and the chances they won’t sell the home do as well. As long as the terms listed as generally acceptable (and obtainable) in the current market, they probably won’t worry much. Even if you are offered a loan that has much more unfavorable terms, if you decide as the buyer to take it and continue on with the purchase, there is no effect to the contract. It’s only if you decide that those terms are unacceptable and they are higher than the base guidelines that were outlined in the Third Party Financing Addendum that it can affect the outcome.
Lots of great points here to mull over as I look at selling a property with owner financing.
Figuring out an interest rate has been a bit of a challenge for me, but I think the idea about choosing a rate that’s a bit higher than market level could give my buyer more motivation to refi, which is preferable to me than waiting out the full course of a mortgage.
Matt Stigliano says
Typically seller financing deals require a higher interest rate than current market rates as the risk is higher than on a traditional lender approved loan. The seller is taking on that financial risk, so often the interest rate they charge is pushed up to accommodate for that. There are also costs associated with a seller financing situation, such as loan servicing and escrow accounts, so these higher interest rates help defray those costs – costs a lender takes on based on the scale of their operations. Seller financing is not for everyone, but it can be a solution for both buyers and sellers that can create the magical win-win for everyone.