If you have never experienced a market where interest rates are climbing steadily, hold onto your hat–you may be in for a wild ride.
October 2005 saw record national home sales numbers. Rather than being encouraged by this, many experts believe this surge is due to buyers purchasing prior to additional interest rate increases. With each interest rate increase, there is a reduction in the number of buyers who can afford to purchase property. The Federal Reserve is expected to continue to raise interest rates during 2006.
Agents who have never done business in this type of market may be in for a rude awakening.
Consider the following scenario: you represent a buyer who purchases a property and is pre-qualified for a 5.75 percent fixed rate loan. You “lock in the rate” (secure the rate for the 60 days while the property is under contract). The fixed rates jump up to 6.25 percent. Even though your buyer is pre-qualified, the lender keeps requiring additional documents before they can “go to committee.” As the closing date approaches, the lender’s in-house appraiser brings the appraisal in at less than the purchase price, even though there are plenty of comparable sales to support the sales price. Now you’re in the unenviable position of having to justify the purchase price to your buyers who think they overpaid. You put together a letter asking the lender to update the appraisal using the comparable sales you provide. The loan contingency is about to expire. The lender refuses to submit the loan to committee until they have the new appraisal. The lock-in period expires and your buyers finally obtain loan approval. Because your lock-in period expired, the lender can no longer fund a 5.75 percent loan. Instead, the lender offers your buyers a 6.25 percent fixed-rate loan or a 4.75 percent adjustable-rate mortgage (ARM) fixed for three years. The buyer doesn’t want either of these two loans and wants to cancel. The sellers talk to their attorney who advises them that if the buyer cancels, the seller can keep the buyer’s earnest money deposit. Alternatively, the sellers can put the property back on the market. If the property sells for less money, the seller can sue your buyer for actual damages (i.e. the amount of difference between your buyer’s contract price and the price that the second buyer pays). The sellers may be able to obtain punitive damages as well. The buyers blame you and threaten to cross-complain against you if there is a lawsuit.
While it may seem that the seller holds all the cards in this scenario, nothing could be further from the truth. In a bad market, many sellers are desperate. Due to transfers, divorce, or other financial difficulties, many people must sell. If the appraisal comes in low, the sellers may have no option but to lower the price or pay for an interest rate buy-down so the buyer can close the transaction.
Sadly, the events described above are fairly common occurrences when interest rates begin a steady upward climb. The problem is compounded when there is too much inventory and prices drop. The lenders become much more conservative in terms of appraisals and are much more likely to require buyers to make substantial down payments, especially if the buyer wants a fixed- rate loan.
How would you have handled this situation? Do you have the skills required to maneuver through this quagmire of difficulties? What steps could you take to circumvent this type of disaster? Here are a few tips:
1. Apply at two different lenders
This is a difficult call to make. If the buyer applies at two lenders and obtains approval at both, it may cost the buyer a substantial amount due to paying two sets of fees. This cost must be weighed against the cost of an increased interest rate or cancellation of the transaction.
2. Meet the appraiser
To minimize appraisal problems, meet the appraiser at the property and give him/her the latest comparable sales data. Contact the listing agents of the properties you include to obtain interior pictures and/or a virtual tour. This is an excellent strategy that provides the appraiser with the best possible picture of the current comparables and market values.
3. Learn about creative financing
When lenders are only willing to make your buyer a loan that is 75 percent of the purchase price, you can often save the day by having the seller carry back part of the financing, provided they have equity in the property. When the seller has no money, you may have to find a “hard money” lender (i.e. a lender who is willing to take a second mortgage) to bridge the gap. In some cases, agents have actually used their commissions to fund the second trust deed themselves.
4. Have your buyers pre-approved, not just pre-qualified
Pre-approval means that the lender has checked the buyer’s credit and is willing to make the loan, subject to the appraisal and the credit report. While this doesn’t eliminate all problems, it does greatly reduce the probability that the buyer will have problems closing. Furthermore, pre-approved buyers have more negotiation power than those who are only pre-qualified.
Shifting interest rates are a fact of life. Are you ready to ride the interest rate roller coaster?
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