New twist in financing? Some non-FHA lenders won’t fund mortgages until repairs listed in inspection report are completed

Repair credits at heart of debate

Editor’s note: This is the first of a two-part series. See Part 2.

An in-house lender for an office in Southern California recently advised its agents that sellers must now complete the items on the inspection report prior to closing. Otherwise, the lender won’t fund the loan. Is the lender just being arbitrary or is this a new twist in the mortgage side of the transaction?

I once sold a home to an attorney with a small baby. The inspection report on the property came back noting roof repairs. The seller advised my buyers that the roof repairs had been completed, and the transaction closed.

Home inspection image via Shutterstock.
Home inspection image via Shutterstock.

During a strong rainstorm a few weeks later, the roof leaked in the exact place where it had supposedly been repaired. Making matters worse, the leak was right over the baby’s crib.

The buyer immediately filed suit against the seller. The court ruled that even though the seller had paid to have the work done (which was supposedly done by the seller’s brother-in-law who was a roofer), the seller was still liable to the buyer. It was up to the seller to pursue his own claim against the roofer who did a poor job.

Because the Southern California market is so litigious, our company encouraged us to arrange for the seller to give the buyers a credit for any work that needed to be done. The reasoning was to avoid the type of situation above. If there was a problem with the work, the sellers and the agents were out of it. The dispute was between the buyer and the buyer’s contractor.

When there was a credit, typically the escrow (closing agent) would withhold 1.5 times the dollar amount in an escrow account from the seller’s proceeds. Once the work was completed, the buyer would submit the receipts and the contractor would be paid. The balance would be returned to the seller.

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Must repairs be completed before closing?

A common red flag with virtually any lender occurs when a seller credit changes the loan-to-value ratio. Lenders typically disallow any credit that reduces the down payment below the lender’s requirement."

When I heard about what the in-house lender had said in my friend’s office meeting, I posted the question to the Raise the Bar Group on Facebook to see if anyone else was encountering this situation. The post generated over 50 responses. A number of agents reported that they had bumped into this issue.

Specifically, broker associate Eric Larkin reported that Wells Fargo will ask for a copy of the inspection report if the buyers inform them they had one. He did not indicate whether Wells Fargo had ever held up funding based upon an item on the report.

Realtor Mary Pope-Handy reported that this has become a major issue in California’s Silicon Valley.

“Understand that unless you are buying ‘as is,’ you will need to show your real estate purchase agreement to your lender, and your lender may want to see inspections, reports or disclosures based on what you’ve written in that paperwork. And then the bank, credit union or lending institute may ask for repairs prior to close of escrow, even in an ‘as-is’ sale.”

Different lenders, different requirements

Fannie Mae, Freddie Mac, FHA, HUD and VA all have different lending requirements, as well as differing policies on how credits in the transaction are handled.

Consequently, if you bump into this situation, the first issue you must address is what are the actual requirements of the lender? To make this determination, ask the underwriter to supply you with the specific regulations for the lender that will be originating the loan.

A common red flag with virtually any lender occurs when a seller credit changes the loan-to-value (LTV) ratio. Lenders typically disallow any credit that reduces the down payment below the lender’s requirement. In other words, if the buyers were putting $20,000 down on a $200,000 property and received a $2,000 credit, the lender would not allow that credit to go towards the down payment. The reason is the $2,000 credit decreases the amount of the buyer’s down payment from 10 percent to 9 percent.

Credits are allowed in certain circumstances. For example, if the closing agent holds the funds and the repairs are paid directly to the contractor rather than to the buyer, then that may be allowable.

When there is a credit, many lenders want more than the receipt for verification.

Broker Barbara Calabrese reports that “companies also hire third-party companies to provide current pictures (50 is not abnormal for window repairs). Either the pictures (field service company) or a new appraisal is done to prove third-party confirmation of completion.”

Fred Glick, who is a mortgage broker, made this observation about lenders asking for inspection reports as a condition of funding the loan:

“Some of the large lenders are starting to do this. As a mortgage broker, I have not had my TPO lenders (third-party mortgage originators) asking for it. Those agents need to find another lender.”

Charles Dailey, who is both a loan officer and an underwriter, and Katy Parsons, who is also a loan officer, both agreed with Glick. According to Dailey: “The only time that a home inspection is required by a lending guideline is in the case of getting a FHA flip waiver — and even then it’s rare.”

Parsons added, “Charles Dailey and Fred Glick hit the nail on the head. Basically if the loan is going to be FHA or VA, there are certain guidelines that must be met, many of which are geared towards health and safety rather than investment protection (handrails, exposed wires, etc.).”

How are agents who are encountering this situation coping? See Part 2 to learn more.

Bernice Ross, CEO of RealEstateCoach.com, is a national speaker, author and trainer with over 1,000 published articles and two best-selling real estate books. Discover why leading Realtor associations and companies have chosen Bernice’s new and experienced real estate sales training for their agents at www.RealEstateCoach.com/AgentTraining and www.RealEstateCoach.com/newagent.


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