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Updated almost 9 years ago, 01/13/2016
Purchase Contracts: Which Happens First?
I've been browsing BP and researching a lot… How do others put a property under contract FIRST, then secure a HML/private equity/crowdfunding for financing AFTER? (I had a pre-approval letter in this instance). Still, you can never be sure the HML is going to come through and if it's a foreclosure which doesn't allow finance contingencies/ or is rehab loan cash-only deal, you then only have 20, 30, "X" amount of days for financing to come through and if it does not, you lose your earnest money deposit for sure?
Over the weekend, a listing agent I met with for a property stated I needed to put down 10% EMD for a property which equaled $12,500. I previously researched that EMD are smaller amounts! I am able to put down that amount in cash, but within the contract it contained a clause I found that if I couldn't secure a HML during a 30 day time period, I would forfeit the entire $12,500/contract terminated. OR I would be fined for each day past 30 it took me to get financing, AND be at risk for extra fees for defaulting on a contract… (Needless to say, no deal obviously, but I'm confused how others put a property under contract first, then arrange HML?)
Hi Shannon,
I'm a Realtor/Investor and what I would recommend is working with a Realtor who lists a lot of foreclosures or investment properties. They will know how to best write up an offer contingent upon financing for foreclosures. I would also have an idea of what private lender you plan to use, so you can move quickly. Once you have the house under contract is not the time to start reaching out to lenders for the first time. If you find a legitimate private lender and lending is their business, they will move quickly.
Each bank/agency will be different and depending upon the price may not accept your offer with the contingency, but I know both Homepath (Fannie Mae) and HUD will. They will also return your earnest money, should you make a reasonable effort to secure financing and ultimately be denied. Here is an excerpt from my contract on my last purchase from Fannie Mae:
If this Agreement is contingent on financing, the Purchaser shall apply for a loan in the amount of $_____19,500__________________ with a term of ___15_______ years, at prevailing rates, terms and conditions. The Purchaser shall complete and submit to a mortgage lender, of the Purchaser’s choice, an application for a mortgage loan containing the terms set forth in this paragraph within five (5) calendar days of the Effective Date, and shall use diligent efforts to obtain a mortgage loan commitment by ________1/22/2106______________________. If, despite the Purchaser’s diligent efforts, the Purchaser cannot obtain a mortgage loan commitment by the specified date, then either the Purchaser or the Seller may terminate the Agreement by giving written notice to the other party. The Purchaser’s notice must include a copy of the loan application, proof of the application date, and a copy of the denial letter from the prospective lender. In the event of a proper termination of the Agreement under this paragraph, the earnest money deposit shall be returned to the Purchaser.
You need to work with an attorney who will help you craft contracts which allow you escape clauses for such things as financing, attorney or partner approval, etc. The attorney will be able to make sure your contract is legal in your target location (they're all different).
You get the property under contract first. THEN, you have a deal you can market to potential money / investment partners.
I know - It can be difficult to let go of the traditional finance paradigm. We were raised with "20% down, bank loan". It's familiar, it's "warm and fuzzy", it's accepted by everyone we know. The sooner you do embrace alternatives, of course, the sooner you will build your portfolio into an income stream which will get you out of your W2 position.
David J Dachtera
"Success is not a destination. Failure is not an event. Success is a process, failure is a choice."
- DJ Benedict
Thank you @Jacqulyn Hughes and @David Dachtera for commenting. @Jacqulyn Hughes if you don't mind, might I take that bolded part of your excerpt and send it to my RE attorney for his opinion so I can be protected?
@David Dachtera how do I get the property "under contract" first? I guess I'm not clear on HOW to do it... I want to put a property under contract first (with my pre-approval letter in hand) so I can then present the deal right away to the HML I'd like to use and within those 30 days, have them approve the amount/arrangement.
The agent that showed me the foreclosure this weekend said I was not eligible to even make an offer on the property without showing a pre-approval letter first. I went home, retrieved my pre-approval letter and brought it back to her. I had the 10% EMD with me and I was not able to put it "under contract" for myself now and receive the HML thereafter...
I assumed (maybe incorrectly?) that I could put the house in my own name right now in her office to save it for myself, give a much smaller EMD, and ask for a financing contingency so my HML might be considered as a cash offer when it came through... Now that I think of it, the HML is still a "loan" but regardless, I was not allowed to "save the house for myself now" and get financing later. I've been on the renovation side of flips before with my partner plenty of times with his work crew, but this is the first time ever trying to put a property in our own name, so I really appreciate the guidance.
@Shannon K. Of course. I got the statement from a Fannie Mae purchase addendum.
As far as how to get a house under contract, this is how it typically works for me and my clients:
1. Get a Realtor - as a buyer you should be able to find one without any costs.
2. Find a house.
3. Have your Realtor prepare the documents for you to submit an offer. You will need to provide your pre-approval letter to your Realtor so that he/she can submit it with your offer.
4. Unless you submit a full price offer, there will likely be some back and forth negotiations.
5. Once you and the seller have come to an agreement, your Realtor will prepare the documents to reflect all the agreed upon terms.
6. *You will need to sign the documents, and submit earnest money.
7. Once the documents are also signed by the seller, you have the house under contract!
*Between steps 5 and 6 is when I am contacting my private lender and providing them with everything they need to make a decision about whether to lend to me or not. This way I know if I need to terminate the contract before I provide any earnest money funds. Typically 2 days max before you need to have the docs signed and earnest money funds. This is not a lot of time, but if you are lucky and get a property under contract late Thursday afternoon, you can usually stretch it out until Monday.
*****Each state is different, so you should work with a Realtor to help guide you through the home buying process or consult an attorney to draft your specific contract needs.
I've also found that if you submit and offer pursuant to "other financing" instead of cash, than you typically do not have to provide 10% in earnest money - just a reasonable amount based on the purchase price.
You're here to be an investor, yes? ... but, you're still thinking like a home buyer: agents / realtors, pre-approval letters, 20% down, banks, etc.
All you really need is an approved contract (by either the state, your attorney or ...), whatever they'll accept as earnest money and the seller's acceptance of your offer. You can choose to include an agent / broker, but remember that reduces your profit in trade for the their services.
Of course, you'll need to learn HOW to make an offer: what's their asking price? Does it jive with the fair market value (FMV)? What repairs / rehab does the property need? How much does that reduce the amount you can offer and still leave room for profit after repair / rehab? Etc.
Once you have the property "tied up", NOW you have time (usually 90 days, maybe less) to line up money partners / lenders, etc.
Now understand: you're not here to rip people off - your escape clauses in your purchase contract are there to protect YOU in case you find something about the property or the deal you can't handle. Then, you can exercise an escape clause: inspection, partner's / attorney's approval, financing, etc.
Jaculyn's not wrong, she's just - again - talking like a home buyer, not an investor. For a home buyer, yes - she paints an accurate picture. For an investor, the process is a bit different.
David J Dachtera
"Success is not a destination. Failure is not an event. Success is a process, failure is a choice."
- DJ Benedict
Thank you @Jacqulyn Hughes! Outlining the steps was very helpful. So essentially there are 2 document signings that take place during an entire transaction:
#1: I first sign documents to present an offer to the seller (I did this this weekend and it was nearly 30 pages of docs/foreclosure info, etc). I then withdrew my offer immediately after my RE attorney confirmed a finance contingency is not allowable on this house and I will not receive my $12,500 EMD back if I can't find a HML in 30 days). Simply presenting an offer to a seller does NOT make me "under contract" though correct?
#2: Had the transaction proceeded further, I would have then signed a second set of documents (if the seller accepted my offer) and I would agree to all terms and be "under contract" at THIS point, if I'm understanding correctly...
I do have my own realtor who is experienced in foreclosures/short-sales/investor-friendly, however, given that this was my first time going after a property on my own, I jumped too soon and simply called the listing agent contact on the property for her help. I didn't know my own realtor could act as both the buying and selling agent for me (after I rehab this property later).
Yes, @David Dachtera, I agree, I do need to learn HOW to make the offer under investment circumstances. This weekend was rather confusing for me with agents telling me 10% down, I'm not allowed to have an inspection, I'm not allowed to use a finance contingency, I cannot turn on the utilities for an inspection even if I pay for turning them on and for rewinterization afterwards. I asked about all of those things. This went against everything I have read about due diligence when buying a foreclosure.
The bank countered another couple's offer, the couple accepted so I couldn't submit an offer. 22 minutes later the bank didn't want to accept the couple's offer so the realtor called me back and now I can submit mine! I submit mine Sunday, oops, now the bank re-accepted the first offer Saturday. Now on Monday I can submit an offer because there's multiple offers on the property. I lost/became eligible for the house 3 times over this weekend!
The listing agent I worked with on this property admitted she had never seen such crazy circumstances/bank accepting offers on Saturdays, etc. Long story short, this was not the property for me! I am comfortable budgeting for the rehab and crunching all the numbers/budgeting for holding/HML costs since I have done that type of work before analyzing my own potential deals and helping with other people's flips. I will take your advice moving forward and look to "tie up" a property the right way an investor would the next time. Thank you, I appreciate it.
@Shannon K. Yes, you are NOT under contract just because you present an offer. In the end, the contract has to be signed by both buyer and seller for a property to be considered under contract.
@David Dachtera I will have to disagree with you that I'm not thinking like an investor. There are many approaches to investing. Mine just happens to work well for me. I have never been in a situation both as an agent or investor where I had 90 days to close. Foreclosures especially have very short turn around times. Banks don't want to wait 90 days for you to find money and take the risk that you never do, when they could sell it to someone else for cash or quicker turn around time. My advice for Shannon to find a Realtor is so that she can learn the process. As a buyer it would most likely be a free service for her. It doesn't do any good to get an attorney, which cost money, to draft you some contracts, if you don't know how to use them.
No slight intended.
The time to close after an offer is accepted is negotiable with some exceptions, like REOs and some other sellers. Ideally, you'd already have relationships with private lenders and other partners or investors so you can find money quickly. The time is needed less to find funding than to do your own due diligence. Banks are loath to do business with investors, though they still do it, albeit grudgingly. So building a "stable" of private lenders is an absolute must.
An agent / broker (they're not all Realtors(TM)) is not usually helpful learning about investing, but can be useful to help learn the transaction process from their point of view. Ideally, you'd want an agent / broker who is also an investor.
It doesn't do any good to have contracts which don't protect you. This is THE one place where you do NOT cut corners. Contracts can get you into more trouble than even your own inexperience. They can also help you avoid trouble in the first place.
Also, remember: agents / brokers are NOT legal professionals. They can help you within the limits of their training in regard to using pre-drafted contracts. They CANNOT draft contracts except to use "template" contracts which are, effectively, "fill in the blanks" and which typically are written to protect the SELLER more than the buyer. Your attorney will not only help make sure YOU are protected but will also guide you in regard to contracts. It helps to build a cooperative relationship with your team-member attorney.
Hope this helps...
David J Dachtera
"Success is not a destination. Failure is not an event. Success is a process, failure is a choice."
- DJ Benedict
Just to chime in, are there truly no contingencies on the property you are pursuing?
Does the bank allow for any sort of due diligence period for inspections? If so, you should be able to back out of the contract based on your due diligence findings. They do not have to be specific. We cancel all the time "based on our due diligence". The only reasons to select a financing contingency is that a lending institution will want to see it in the contract and that the seller is alerted to the timeline. Most sellers allow for a due diligence contingency. Use that as your escape route to protect your earnest money if you have to back out for any reason.
If there are truly no contingencies, this becomes a high risk property and you have to know what you're doing. We buy houses on the courthouse steps which are cash purchases and very much as-is. The reason we can do this is we price in the risk. These properties have to be at a deep discount to account for unforeseen problems.
If you're not even allowed a due diligence period, I would recommend moving on to another property until you have a little more experience with mold, broken sewers, roof leaks, meth, etc.
I just heard from a friend who bought a house in SF that, because of the competition in the market, did not allow for any contingencies. He would have been better off walking away from his $20K EM, than buying the money pit he did. There will be law suits.
Good luck.
@William Hochstedler, I was indeed told for this particular property there were no inspection contingencies allowed, no financing contingencies allowed, and a hard-money loan would not be considered allowed on this property either. I have not looked into a due diligence contingency. I will definitely research that, thank you.
I did withdraw my offer after my REI attorney confirmed no contingencies would be allowed and I was also not allowed to "dewinterize" and "rewinterize" the property for any reason even if I paid for it. This particular property was just filled with unusual circumstances and was certainly not the one for me. Additionally, I now have my own buyers agent who is familiar with HML as the listing agent I worked with on this particular deal was not familiar.