Many housing-market experts consider a six-month supply of homes for sale as a sign of a healthy real estate environment. Housing-supply levels of more than six months could result in lower prices due to oversupply while fewer than six months could cause demand and prices to spike. According to the National Association of Realtors (NAR), nationwide unsold inventory had fallen to 2.6 months as of July 2021. This type of ultracompetitive real estate market should put mortgage originators on notice.
Understanding the background of the current market could help originators to better prepare prospective buyers when attempting to qualify them for a loan. Early this year, for instance, a Bloomberg Businessweek reporter provided evidence that “the force behind the price rise is a supply shortage, not a speculative frenzy.” There are simply more people buying homes than there are homes for sale. Knowing the reasons for this competitiveness may help create a sense of urgency for originators, transaction coordinators, processors and everyone else on a mortgage team.
Heavy competition in the housing market has created an alarming trend that originators should take note of. In some regions of the U.S., buyers are choosing to waive appraisal and loan contingencies. NAR reported this past July that each home sold during the month had received an average of four offers. Multiple offers give sellers an advantage in their ability to demand more stringent closing terms. The sheer number of offers being submitted has already spurred listing agents to develop weeding-out methods. Right now, this is occurring in the form of contingency removal.
Loan contingency and appraisal contingency are separate processes, but both serve as a defense for the buyer, who typically has a few weeks to make sure their loan can get approved and that the target property is worth the sales price. The clock to resolve a contingency starts ticking on the contract acceptance date. And the removal of these layers of defense, as crazy as it may sound, is what today’s buyers are facing.
Real estate contracts are designed with an appraisal contingency that is meant to protect a buyer from a wrongly priced purchase. Appraisals determine value based on the sales of multiple like-kind properties. In the past, this contingency was rarely removed, but due to rapid price growth and an ongoing inventory shortage, it is now becoming an industrywide reality.
Mortgage lenders do not cover the difference when the appraised value is lower than the agreed-upon contract price. So, if a buyer’s offer for $400,000 is accepted but the appraised value is only $375,000, the transaction is stuck and an addendum is needed to cover the $25,000 difference. In this situation, either the seller accepts a lower price or the buyer adds more cash to the transaction.
Dealing with a buyer who provides more cash halfway through the escrow process is a difficult task unless the price difference is relatively minimal. If the difference is $50,000 or more, however, it can be quite complicated. Why do contract prices often go so much higher? It’s because of multiple-offer scenarios that raise bids above the original asking price.
The loan contingency is meant to protect buyers and sellers from the results of a negative loan qualification outcome. Buyers typically have a few weeks to figure out whether they can qualify for a mortgage without being penalized through the loss of their earnest-money deposit.
Credit blemishes discovered during the loan contingency window allow buyers to recoup their earnest money unless otherwise agreed upon. Recent experiences in certain markets such as San Francisco, however, show that the removal of the loan contingency creates a dire escrow situation. Mortgage originators should fight for a contingency period of at least one week for the loan submission and underwriting review.
There is a bigger discussion to be had in regard to buyers who are essentially being forced to waive contingencies. The morality and ethics of unprotected escrow accounts should be put on the to-do lists of real estate governance bodies. For now, originators must find ways to navigate these sticky situations until policies catch up. Here are some suggestions that may help when qualifying a buyer in a real estate scenario with multiple contract offers.
A prequalification letter with as much detail as possible could help separate a buyer from the pack. Including such items as credit scores, the debt-to-income (DTI) ratio, the downpayment amount and length of employment may offer more insight into the buyer’s situation. In turn, this may add to the comfort level of the seller.
Getting to this point of information sharing with Realtors requires dedication in getting as much of the qualification work done as early as possible — and before a contract offer is made. This is not an easy task because buyers tend to find a house first and the financing second. Sometimes, buyers are on the fence with a purchase until the right property grabs their attention, which makes early qualification a challenge. It then becomes a desperate situation when the loan contingency protection period is under attack.
It’s important to know the maximum eligible loan amount when shopping in an extreme seller’s market. In some instances, buyers request an approved loan amount based on a specific home price rather than asking for their maximum eligibility. This is valuable information if the buyer ends up in a bidding war and needs to know their approved limit right away. Maximum loan amounts are based on funds for the downpayment and DTI ratios. When the purchase price increases, so do DTI levels and downpayment requirements. It is empowering for a buyer to know their maximum approval amount, even if buyers usually elect to purchase something slightly below this limit.
Advocacy efforts by mortgage originators have proven beneficial for buyers stuck in multiple-offer scenarios. Listing agents have the tedious task of previewing and screening the qualification merits of each offer. They usually reach out to the loan originator on each offer and wait for them to respond. A proactive originator who effectively advocates for their clients via phone or email adds another level of certainty. Listing agents base their recommendations to sellers on the level of certainty that the buyer will be able to close escrow. Alleviating this task through proactive outreach to the listing agent could prove to be a differential factor if all other offers are reasonably equal.
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Not all regions of the country face the same level of hyperdemand, even though the U.S. average is about four offers per listing. Price increases also are indicative of demand. This past June, for example, the S&P CoreLogic Case-Shiller Index showed that Phoenix, Seattle and San Diego had the steepest home-price appreciation over the previous 12 months. Cities such as Tampa, Miami, Dallas and San Francisco were not far behind. ●