The Arizona REALTORS^® Residential Resale Purchase Contract: Financing Section – Contingencies

This is Part 3(b) of a series of articles discussing the major provisions in each of the sections of the Arizona REALTORS^® Residential Resale Real Estate Purchase Contract (10/22) (“Contract”). Since most residential resale transactions involve financing, it is critical to understand the loan contingency in the Contract and the loan process. The previous articles in this series can be located at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com). 

LOAN CONTINGENCY (2b)

The buyer’s obligation to complete the sale is contingent upon the buyer obtaining loan approval without Prior to Document (PTD) conditions no later than three days prior to the close of escrow (“COE”), Date for the loan described in the Arizona Association of REALTORS^® (“AAR”) Loan Status Update (“LSU”) form, or the AAR Pre-Qualification form, whichever is delivered later.

• When the seller receives an offer with a completed AAR Pre-Qualification Form, be aware and discuss with the seller that the buyer may be entitled to change financing programs and the terms of the financing contingency in the Loan Status Update, which must be delivered ten days after Contract acceptance. 

• If the seller’s reason for accepting an offer is the loan program submitted in the Pre-Qualification Form, discuss with the seller the advisability of responding with a counteroffer, for example: “Buyer agrees not to change from a Conventional loan program” and/or “Buyer agrees not to enter into a down payment assistance loan program.”[1]  

LOAN STATUS UPDATE (2e)

The buyer is obligated to deliver to the seller the LSU with, at a minimum, lines 1 – 40 completed describing the status of the Buyer’s proposed loan within ten days after Contract acceptance and instruct the lender to provide an updated LSU to the brokers and the seller upon request.

As discussed above, in many cases, the LSU will set forth the terms of the buyer’s loan contingency.

The LSU is also designed to assist both brokers and buyers follow through on the four main parts of the loan process: 

• Pre-Qualification
• Documentation
• Underwriting and Approval
• Closing

Consider using the LSU as an educational tool for both buyers and sellers. 

• The LSU lists all the major steps that must be completed before the buyer obtains loan approval and can close escrow. 

Both the listing agent and the buyer’s agent should review the LSU carefully, provide copies to the clients and request updates as necessary.  

• If the updated LSU changes the terms of a completed Pre-Qualification Form submitted with the offer or LSU submitted ten days after Contract acceptance, the change may require the seller’s written approval pursuant to section 2k if the change adversely affects the buyer’s ability to obtain loan approval without conditions, increases the seller’s closing costs, or delays COE.

If the buyer fails to deliver the LSU with, at a minimum, lines 1 – 40 completed within ten days after Contract acceptance, the seller should deliver a cure notice to the buyer pursuant to section 7a of the Contract.

• If the buyer fails to deliver the LSU within three days after the cure notice, the buyer is in breach of contract and the seller can pursue all remedies.

If the buyer’s lender refuses to complete an LSU, the buyer should complete, at a minimum, lines 1 – 40 of the LSU on their own.

• The failure of the buyer’s lender to complete the LSU is not a potential breach and, therefore, not subject to a Cure Period Notice because the lender is not a party to the Contract. However, the lender’s refusal to complete an LSU could be a ‘red flag’ of possible financing issues to come. 

It is vitally important to remember that in most transactions the lender will update the condition of credit reports, employment status, and buyer’s funds immediately prior to funding, even though there may not be an official condition or indication that the lender intends to do so. In fact, the lender may update this information several times during the loan approval process.

• Advise the buyer that any credit applications, employment changes, or any major expenditures during the loan process may place the loan approval and funding in jeopardy.

CHANGES (2k)

The buyer is obligated to immediately notify the seller of any changes in the loan program, financing terms, or lender described in the Pre-Qualification Form attached with the offer or the LSU provided within ten days after Contract acceptance.

The buyer is only permitted to make any such changes without the prior written consent of the seller if the changes do not:

• adversely affect the buyer’s ability to obtain loan approval without conditions,
• increase the seller’s closing costs, or
• delay COE.

APPRAISAL CONTINGENCY (2l)

The buyer’s obligation to complete the sale is contingent upon an appraisal of the Premises acceptable to the lender for at least the purchase price. If the Premises fail to appraise for the purchase price in any appraisal required by the lender, the buyer has five days after notice of the appraised value to cancel the Contract and receive a refund of the earnest money or the appraisal contingency shall be waived, unless otherwise prohibited by federal law. 

• If the buyer is applying for a FHA or VA loan, the waiver of the appraisal contingency is prohibited by federal law. Unlike other types of loans, FHA and VA buyers cannot waive the appraisal contingency.

• If the appraisal comes in below the purchase price and the buyer can make a strong argument that the appraisal is low, the buyer can request that the lender order a second appraisal. Otherwise, the seller can lower the purchase price, or the buyer can waive the appraisal contingency, if allowed, and pay the difference between the purchase price and the appraised value (loan amount) at COE.
• If the buyer waives the appraisal contingency and is thereafter unable to close escrow due to the appraisal, the buyer will forfeit their earnest money.

Although the buyer is instructed to conduct all desired inspections to determine the “value and condition” during the Inspection Period, the appraisal contingency is a separate contingency related solely to financing.

APPRAISAL COST(S) (2m)

This section indicates who will pay the initial appraisal fee when required by the lender and if the seller is paying the appraisal fee whether the fee will apply against the seller’s concessions. The buyer also agrees to pay for any updated lender required appraisal and to pay for any lender/appraiser required inspection costs.

Three Days Prior to COE (2b)

No later than three days prior to COE, the buyer must complete one of the following:

(i) Sign all loan documents.

OR

(ii) Deliver notice of loan approval without PTD conditions and dates of receipt of Closing Disclosures from lender.

• PTD conditions are what lenders call all the actions/approvals necessary before the lender orders the closing loan documents and instructions. PTD conditions include items that must be provided and reviewed by the underwriter before the loan documents can be ordered.

• This information is important to the seller because it will help the seller understand when the transaction may close escrow. The loan cannot be consummated (i.e. – execution of the promissory note and deed of trust) less than three business days after the Closing Disclosure is received by the buyer.

OR

(iii) Deliver to seller or escrow company notice of inability to obtain loan approval without PTD conditions. 

• To give everyone involved in the transaction notice of an unfulfilled loan contingency, the buyer is obligated to deliver a notice of the inability to obtain loan approval to the seller or the escrow company no later than three days prior to the COE Date.

• If the buyer fails to deliver this notice by three days prior to the COE Date, the seller must give the buyer a Cure Period Notice pursuant to section 7a of the Contract, and a three-day opportunity to deliver the notice of the unfulfilled contingency.

• If the buyer fails to deliver the notice, the buyer is in breach (not for the failure to qualify, but for the failure to deliver the notice) and the seller agrees to accept the earnest money as damages as set forth in section 7b.

UNFULFILLED LOAN CONTINGENCY (2c)

The Contract is cancelled for an unfulfilled contingency and the buyer is entitled to a return of the earnest money if, after a diligent and good faith effort, the buyer is unable to obtain loan approval without PTD conditions and delivers the notice of inability three days prior to the COE Date.

The inability to obtain loan approval three days prior to the COE Date after a diligent and good faith effort is not a breach of contract. In other words, the inability to obtain loan approval does not trigger a curable event and therefore, the Cure Period does not apply to extend COE.

• If the loan contingency is not fulfilled, the buyer has no obligation to close escrow. Therefore, the Contract can be considered cancelled, terminated, or unenforceable against the buyer.

• Even though the Contract is no longer enforceable against the buyer, written mutual cancellation instructions should be executed.

• If the parties agree to allow the buyer additional time to obtain the loan, the parties should execute an amendment to the Contract extending COE.
  

However, the failure to deliver the notice of the inability to obtain loan approval is a potential breach and the seller should issue a cure notice. If the buyer fails to deliver the notice before expiration of the Cure Period Notice, the seller is entitled to the earnest money.

• Although the buyer’s obligation to close escrow terminates due to the unfulfilled contingency, the seller still has the right to enforce the buyer’s obligation to deliver notice.

• If the seller believes that the buyer obtained loan approval or that the buyer failed to make a diligent and good faith effort to obtain loan approval, the seller should contest the notice in writing to both the buyer and the escrow/title company.
  • If the buyer does not produce evidence of the inability to obtain loan approval after a good faith effort that is satisfactory to the seller, the seller can request that the escrow/title company release the earnest money to the seller. If the escrow/title company holds the earnest money due to the dispute or releases the earnest money to the buyer, the seller can initiate mediation to resolve the dispute.
  • Any such buyer/seller mediation is strictly between the parties and should not involve the agents. However, if such a dispute does arise, the agents involved in the transaction should notify their broker or manager.

INTEREST RATE/NECESSARY FUNDS (2d)

The buyer agrees that (i) the inability to obtain loan approval due to the failure to lock the interest rate and “points” with the lender during the Inspection Period or (ii) the failure to have the down payment or other funds due from the buyer necessary to obtain the loan approval without conditions and close this transaction is not an unfulfilled loan contingency.

• The Contract does not require the buyer to lock the interest rate during the Inspection Period, however the failure to lock the interest rate can put the buyer at risk of closing at a higher rate or breach of contract. 
  • For example, if the buyer’s Pre-Qualification or LSU stated an interest rate not to exceed five percent, and the buyer qualified and could have locked at five percent, but failed to do so during the Inspection Period, the buyer is at risk of being obligated to close at a higher rate. If the buyer can get the other loan terms described in the Pre-Qualification Form or LSU at six percent at COE, the buyer will be obligated to close escrow or will be in breach of contract (after the expiration of the cure period).

• If the buyer does not lock but cannot obtain loan approval for a reason other than the interest rate, the Loan Contingency is unfulfilled, and the buyer is entitled to a return of the earnest money.

CONCLUSION

Although the number of all cash sales have increased in recent years, most residential resale transactions involve financing. Therefore, it is critical that real estate salespersons understand the loan contingency in the Contract and the loan process.    

Next Article – Title and Escrow Section

K. Michelle Lind, Esq. is an attorney who currently serves Of Counsel to the Arizona REALTORS^®. She is also the author of the book – Arizona Real Estate: A Professional’s Guide to Law and Practice (3rd Ed.) .

For more real estate related articles, visit Michelle’s Blog at Arizona Real Estate – A Professional’s Guide to Law & Practice. (arizonarealestateprofessionalguide.blogspot.com)This article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel. 2/27/23

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[1] Thank you to Mandy Neat for this suggestion. 

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