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 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