Getting from contract to closing: the most challenging part of a home sale
Congratulations, your home is now under contract. The period from now until closing is actually the most challenging part of selling a house, and the period during which most issues occur. The buyer must obtain financing (unless they are paying cash); you and the buyer must negotiate the buyer's inspection (see step 19); and the title company must review and issue a title insurance commitment for the property.Click here for your free guide!
Mortgage application and approval process
It's critical for you to understand the buyer's mortgage approval process. You may now have your house under contract, but you don't receive any money until such time as the buyer obtains a new loan for the purchase and closes on the property, or brings cash to closing. Most homes in the United States are financed with a new mortgage loan. The loan process is critical to you, the seller, because any hiccup in the process could affect your closing (the sale of your home). Stay on top of this by getting weekly updates from the buyer or buyer's agent regarding where they are in the loan approval process.Real estate contracts in some state include a "Loan Approval Deadline", which specifies a date by which the buyer must receive loan approval from their lender. If they do not have loan approval by that deadline, they will be "out of contract" and the contract will terminate (unless that deadline is extended via a contract modification/extension – a form signed by all parties modifying or extending contract terms such as the "Loan Approval Deadline"). Check with your state real estate commission (or just look at the contract form) to determine if this applies in your state.
The mortgage approval and closing process consists of the following steps:
- Pre-approval
- Application
- Credit review
- "Approval", subject to contingencies
- Submission and review of required financial documents
- Appraisal of seller's home
- Final loan approval
- Loan documents and loan proceeds sent to closing/escrow agent
- Closing
Mortgage Pre-approval
Pre-approval consists of a lender providing a borrower a "pre-approval" letter stating that the borrower appears to be qualified for a mortgage loan up to a specific amount, such as $250,000. Pre-approvals (also called pre-qualifications) are often based upon information gathered in a telephone conversation between lender and buyer. The lender does not typically perform any analysis prior to issuing a pre-approval letter. As such, these letters often contain language stating that they are not a commitment to lend money, and that a full application and review is required in order for the buyer to obtain full loan approval.Many a seller has put their property under contract based on a "pre-approval" letter only to find out "post-underwriting" process that the buyer did not ultimately qualify for the loan and therefore was unable to complete the transaction. Don't assume that a pre-qualification letter ensures that the buyer will be able to obtain a mortgage loan to purchase your home.
Home Loan Application
The US Department of Housing and Urban Development (HUD) has created a standardized mortgage application (Form 1003), which is used by most mortgage lenders in the US. See a sample Form 1003 mortgage application mortgage application.The buyer completes this application, either in-person with the lender, over the telephone, or online. Real estate contracts in some states include a "Loan Application Deadline." The buyer must submit their loan application (Form 1003) to their lender on or before the "Loan Application Deadline", or risk being "out of contract." Check with your state real estate commission (or just look at the contract form) to determine if this applies in your state.
Credit review
Mortgage companies rely heavily on a merged credit report, which reflects a borrower's credit history including any defaults, judgments, late payments, etc., reported to the three major credit bureaus (Trans Union, Equifax, and Experian).Additionally, most lenders rely on what is called a FICO® score, which is a credit risk score based upon the results of the merged credit report. The FICO® score helps the lender in determining the borrower's creditworthiness. FICO® is a registered mark of the Fair Issac Corporation, the firm that compiles the merged credit bureau scores.
If your buyer does not get past the credit review part of the mortgage approval process, it's likely that you will have a difficult time selling your house to that buyer. You may be able to do some Internet research on your own to try to help connect them with another lender. Credit standards have tightened recently; a buyer not meeting minimum credit guidelines may find it difficult to obtain a mortgage loan.
Mortgage "approval"
Mortgage "approval" is not really an approval. It's more of a statement that the buyer's application and credit review appear to fall within the approval guidelines of the lender, but additional review of all of the mortgage application figures and the buyer's personal financial documents is necessary before issuing "final mortgage approval."The lender "underwrites" a borrower's creditworthiness including:
- Income available to service the debt of a mortgage loan
- The borrower's credit scores and credit history
- Collateralization of the property being purchased relative to "Loan-to-Value" ratios in the event that they borrower defaults. That is, can the sale of the property pay off the loan in the event of default?
- Other key borrower financial ratios given the underwriting and investor requirements
Loan Contingencies
After receiving mortgage approval, the buyer must still meet certain obligations to obtain final mortgage approval. These obligations are mentioned above, and may include:- submission of and satisfactory lender review of pay stubs or other proof of income
- submission of and satisfactory lender review of income tax returns
- submission of and satisfactory lender review of bank account statements (to verify down payment and monthly mortgage payment funds)
- possible review of investment accounts (to verify source of down payment funds)
- employment verification
- appraisal of the property with a resulting value satisfactory to lender and sufficient to collateralize the requested loan
Home Appraisal
The appraisal of your home is an important step in the buyer's mortgage approval process. Many home purchases either fall through, or have to be re-negotiated, due to the appraised value coming in lower than expected. Because of the recent fallout in the "sub-prime" mortgage arena, appraisal standards have tightened. (In the "sub-prime" market, lenders who issued loans to borrowers with sub-prime credit have experienced high levels of defaults on those loans; also appraised values of those borrowers' homes were also overvalued.)When a buyer borrows money to purchase a home, the lender takes the home as collateral for the loan. Any loan default by the borrower can cause the lender to declare a defaulted loan and possibly to foreclose on the home. The lender then sells the home to try to pay off the loan balance.
Lenders will loan up to a certain maximum "loan-to-value" on a home. This loan-to-value can vary, but is rarely 100% of the value of your house. Therefore, any appraisal value that is lower than expected can cause the lender to lower the approved loan amount. Unless the buyer can cover that difference with cash, you'll have to lower your price to close the transaction. Here is an example:
Contract price of your home: $300,000
Buyer's "approved" mortgage amount: $285,000 (95% of purchase price)
Buyer's down payment: $15,000
Appraisal value of your home: $290,000
Buyer's new approved mortgage amount: $275,500 (95% of appraised value)
To meet the contract price of $300,000, the buyer would have to provide a down payment of $24,500, which is almost $10,000 more than they were expecting. If they do not have that cash available, the transaction may terminate, unless you lower the price of the home to $290,000. This is not a good situation for you, as the appraisal typically does not occur until just before closing. So, a week before closing, you may find out that you have to lower the price of your home if you want to close. You may be able to prevent this situation by doing a little legwork with the appraiser in advance.
To try to maximize the appraised value of your home, you may want to provide the appraiser with some comparable home information that favors the contract price of your home. For this, you can use the home value research that you or your real estate agent prepared in steps 2 and 14. Appraisers are supposed to be 'independent' of anyone in the transaction, and should not be influenced by the buyer, seller or lender. However, you should try to do everything possible to maximize the appraised value of your home.
When the appraiser arrives to view your home, provide the appraiser with a list of currently for-sale and recently sold comparables. Make sure they are comparables that support the asking price of your home. The appraiser is under no requirement to use those comparables in their appraisal, but may use those they feel are valid. It's certainly worth the minimal effort involved to try to get a good appraised value for your home.
Final loan approval
Assuming that the appraised value was OK, and the buyer has passed all of the lender's underwriting requirements and financial review processes, the lender will issue final loan approval. This means that the buyer has met all of the contingencies specified in the lender's mortgage "approval" discussed earlier in this section. Upon hearing that the buyer has obtained final loan approval, you may breathe a sigh of relief (probably for the first time since you listed your home for sale!) and prepare for the closing.
Loan documents and loan proceeds
The buyer's lender will forward loan documents and loan proceeds directly to the closing (escrow) agent. The closing agent can be a title company, escrow company or attorney. Hopefully, the loan documents and proceeds arrive days ahead of closing. More often than not, they'll arrive the night before, or even the morning of, your closing. Make sure to stay in touch with the closing agent and the buyer's real estate agent in the days prior to closing to ensure that all steps are complete, and that the buyer's lender's package has arrived and is in-hand. The closing is covered in step 20.
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