Why you need a financing condition

Whether it is in the heat of competition or just confidence in your financing, you might be tempted to remove or not include a condition on financing.  You're pre-approved by the bank, so you should be fine right?

Maybe, but not necessarily.

Unless you're buying the house all cash and don't need a mortgage at all, you might want to re-consider your decision not to include a financing condition, and here are a few reasons why.

1. Are you properly pre-approved?
Most independent mortgage brokers will get all the information they need and do a proper credit report when pre-approving you.  Big banks, however, will often not thoroughly discuss income and debt not reported on credit reports, and sometimes base your pre-approval on your history with them without even doing a full credit report up front. Obviously, this can lead to some troubling reversals after an offer is made and submitted for financing and they see something they don't like on your full credit report or financial information.  And even if you're the poster child for fiscal responsibility, no system is perfect and there could be errors on your credit report which will need to be address and fixed - a process that can take time.  I've seen this happen.  Fortunately, a mortgage broker caught it while doing a pre-approval, and the client was able to first get it resolved before proceeding to shop for a house.  That would have been a very stressful time if they had already bought a house and couldn't close.

2.  Discrepancies between credit reports
Similar to the surprise of errors, there can also be discrepancies between one report and another.  I have seen a full and proper pre-approval done on a client.  Then when the offer was submitted, a credit issue still came up.  Why?  The broker pulled a report from one of the major Canadian credit reporting companies and it showed clean.  The lender, however, pulled a report from the OTHER major credit reporting company, and there was an old credit issue that had fallen off of the first report but was still reported there.  It was enough to disqualify them from financing and they didn't have a lot of options for lenders at the time.  It could be differences in the time the company keeps an item on your history, or it could be an error on one not showing on the other.  But either way, there could be a discrepancy between one report and another that leads to problems.

3.  Sometimes "appraisals go bad"
Even if everything is okay for the qualification and the bank wants to lend you a million dollars, the mortgage appraisal may come in lower than expected.  If the mortgage company feels the property is worth less than you have offered, they will only give you a mortgage based on that amount.  So as an example, you have offered $700,000 but the lender's appraiser thinks it is worth $550,000, they will give you a mortgage based on $550,000 and you will have to cover the shortfall out-of-pocket.  If you're in a conditional sale, you have options such as trying to negotiate a price reduction or walking away.  But if you don't have the financing condition, you are in a binding contract to close at that price and failure to do so could result in a lawsuit and at the least, the loss of your deposit.  For a bit more on this, visit previous article [ "When appraisals go bad" ].

4.  The property also needs approval

Besides your financial qualification and the appraisal, the lender is going to look at the property itself. They could take issue with any number of things about it from property condition to location. I've seen one lender refuse to approve a purchase in the country because of railroad tracks they felt were too close, and that buyer didn't have a lot of lenders to choose from based on their personal situation.  I've also heard of problems with mortgage insurance cropping up unexpectedly because of a house being a former grow-op - something the buyer couldn't have known but was on record with the insurer!  You never know what might come up.

So, unless they are in a very strong cash position, I always advise my clients to keep some kind of financing conditions if possible, even if they have been pre-approved.  Removing them can be a real risk with some factors beyond your control.

"When appraisals go bad"

 You've got your offer in on a property and it was accepted.  Yay!  Now you get to work on fulfilling your conditions, including financing.

Whether through you or your real estate agent, the bank or mortgage broker will want a copy of the Agreement of Purchase and Sale (formal name for the contract often referred to simply as "the offer").  They will enter the transaction into their system and it will go through a number of approval steps behind the scenes.

One of these steps may be a formal value appraisal.  Banks do this to protect themselves from over-financing properties, whether by innocent buyer enthusiasm or by fraudsters looking to make easy cash.  An appraiser has specialized education in real estate value assessment, should have a proper certification, and often is on a list of approved qualified appraisers that the specific lender will accept.

The appraiser's job, in a nutshell, is to look at sale history for the marketplace and determine whether the offered price is reasonable based on that evidence. Appraisers do not "set" the value of a property - it's more like they "uncover" the value, by making adjustments to real sales to account for differences and determine a proper value range.

Of course, you generally don't care how the appraiser comes to the value they come to, as long as it is at least what you have offered.  If it isn't, then you have a problem.

It can be very difficult (if not impossible) to challenge an appraisal value, and the bank will only lend based on what they think a property is worth, so if you have offered $700,000 on a house and they feel it is only worth $550,000, then they will only give you a mortgage based on $550,000.  If you want to continue with the purchase, you will have to come up with the down payment for the $550,000 plus the full $150,000 shortfall.

Where this can really be a problem is if you have made a higher offer to win the purchase in a bidding war and perhaps allowed yourself to also (unwisely?) remove the financing condition to make your offer more attractive, because you are now legally obliged to buy without any easy way to back out.  And that could hurt, with an expensive purchase or a lawsuit if you fail to close.

Some appraisers will deny it but there is sometimes room for judgement calls on adjustments, so you might be able to arrange a mortgage through a different lender who will do their own appraisal, and that new appraisal might come back acceptable. But you'll be stressed out and scrambling, and there is no guarantee another appraisal will make a difference.

Bottom line advice: always try to include a mortgage condition unless you are buying all cash or you are ready to make up any large shortfalls to the financing.