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Contingency In The Closet
You want to buy a new house.
You plan to sell the one you own to raise the down payment.
In the first visit with your Realtor, or after days or weeks of house-hunting, or during an exploratory conversation with a mortgage lender, you discover that until you find a buyer for your house, no seller will accept your offer to buy.
It doesn’t seem fair: if the market is so hot, why doesn’t the seller understand that your home will sell as quickly as hers?
Because the seller doesn’t want to take her home off the market, waiting for a possible sale -- no matter how likely -- and risk missing an offer from a buyer ready to close.
The answer is the same from everyone: once you have found a qualified buyer for your home, and its sale is under contract, then sellers will tend to accept your offer. They will wait for a deal, but not for you to find a prospect.
Enter the cruel mysteries of “bridge” financing. A bridge loan is not a specific product, it is a practice: to extract or pledge the equity in your unsold home to assist in financing a new purchase. There are dozens of different ways to build a bridge: one or more second mortgages, lines of credit, temporary loans for acquisition; possibly in combination with your permanent loan, possibly not. Sometimes these bridging structures are secured by your unsold home, sometimes by the new one, sometimes by both homes, or by some other asset, perhaps a brokerage account.
The conclusion is always the same: unless you have a pile of cash to inject into the transaction, you will have to borrow the entire purchase price of the new home. Even if interest is deferred until your current home closes and the bridge can be folded up, during the bridge you will carry the cost of your current mortgage, plus interest running at the better part of a percent per month on the whole purchase price of the new house.
Gulp.
If we don’t bridge, and put our house on the market now, and it sells in an hour, how do we know we will find a new one we'll like? The market is so hot that there’s not much to look at. We can’t possibly sell, rent, and move twice.
We could jigger the closing date way out, ask to rent the house back from the new owners for a while, even make our sale conditioned on our finding a new place to buy. But then, maybe we won’t get such a good deal on our sale.
What if...? What if... we just write an offer that isn’t contingent on the sale of our house? Just leave out the contingency? If ours doesn't sell in time, our loan will be turned down, and the whole deal would just... end, and we would get our earnest money back. The seller wouldn’t be happy, but it’s a very hot market, and they’ll find another buyer.
Right? Sort of... except, maybe that part about the earnest money. And harm to the seller.
Enter the lender, asked to write a pre-approval letter to accompany the no-contingency contract. The lender has an absolute duty under the Privacy Act to hold confidential any borrower financial data. Should the lender insert a contingency, as in “...pre-approved conditioned on the sale....”?
Lenders are not the agent of either party, and have limited motivation to commit professional suicide. “Well, Mr. Banker, if you think you have to put that line in our pre-approval letter, we’ll just find another banker.”
Instead, the lender may try to cover the contingency with an elaborate bridge (sometimes, the fig-leaf kind), which the borrower could deploy, but perhaps should not. “Mr. & Mrs. Buyer, this is the way a bridge would work. It’s extreme, I know, but credit is so easy today that you would be approved if you decided to use it....”
In the pre-approval letter, does the lender have a duty to estimate any difference between the buyer’s ability to bridge and the buyer’s willingness to accept the bridge if the buyer’s home doesn’t sell in time? It’s one thing to be pre-approved for a bridge at the moment you’re sure your house will sell, and another thing entirely -- a month later, no buyers -- to sign on an enormous obligation.
Realtors have all sorts of duties to discover and to disclose, limited by requirements to preserve confidentiality. However, there are limits to discovery: none of us can be certain of another’s intent.
There are dozens of other opportunities in the contingency closet: proceeds from a divorce settlement, a bonus, or from a stock sale; affirmation of a new job offer, or a raise. But the most difficult -- emotionally, financially, ethically -- is how to handle a home-sale contingency.
There is no slipperier slope: fundamentally honest people who would not betray their own sense of ethics or knowingly hurt a seller discover one morning that... it's too late.
(Lest I appear to deliver these remarks from a superior moral plane... I write shortly after participating as a lender in a bungled closet contingency, wishing I had done a couple of things differently.)
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