John and Sally have found their dream home in Westboro. Listed at $425K, it is just within their price range. They have been pre-approved to carry a mortgage of $340K and they have $85K saved for a down payment. They worked hard to save the 20% required to avoid CMHC default insurance premiums. Their lender has approved them based on a 80% Loan to Value ratio. Sounds as though they can go ahead and purchase the home without needing a financing clause in the offer. But should they waive the financing?
Obtaining adequate financing for your new home purchase can be a balancing act.
The financing clause in an offer to purchase is used to protect the buyer and it covers all aspects of obtaining a mortgage that is SATISFACTORY to the buyer. This means that if the buyer is not satisfied with the rate, term, or bank appraisal of the home, they are able to walk away from the purchase and receive their deposit back in full without penalty. John and Sally for instance, could walk away from their purchase if the bank were to appraise the home for less than their initial offer to purchase.
Typically, a lender will appraise the property and offer a mortgage up to the individual’s approved financing Loan to Value ratio. For John and Sally, the lender would offer the lesser of:
a) up to 80% of the appraised value of the home or
b) the agreed upon purchase amount.
Since John and Sally are approved for a Loan to Value ratio maximum of 80%, this is how their financing would look:
Mortgage amount based on Loan to Value: $425K x 80% = $340K
Down payment: $85K
Purchase Price: $425K
Banks will often perform an independent appraisal of the property being purchased before approving the loan. Appraisers do not consider current market conditions, emotional purchases, and what is currently for sale. When they value a home, it is mainly based on objective observations of previous sales in the area that are of similar size and condition as the home in question. When there is a limited supply of homes and the demand is high, multiple offers and bidding wars take place in desirable neighbourhoods. Homes can sell for $40K – $50K (and even $100K!!) over the original asking price. A financing condition protects the buyer against a bank appraisal result that is lower than what they have offered for the home, as well as other financing related issues such as interest rate changes and mortgage fine print.
So, what happens if the appraisal results in an amount that is less than the signed agreement of purchase and sale? These would be the implications to John and Sally:
Bank Appraisal result of the property: $410K
Mortgage amount based on Loan to Value: $410K x 80% = $328K
Down payment required: $425K – $328K = $97K
Now John and Sally will need an extra $12,000 in order to satisfy their lender’s borrowing condition. Can they afford this home?
A financing condition therefore, should be used by buyers in most offers to purchase. A tricky scenario is the bidding war situation which may require the buyer to waive all conditions in order to present a competitive offer to sellers of a highly desirable property. (See Multiple Offer blog post below for more information on dealing with multiple offer situations.)
In order to avoid delays and possible disappointment, buyers should do their homework BEFORE embarking on a home search. Get properly pre-qualified by a bank or lender. In order to get an accurate pre-approval, your lender will need to run a credit report, do a review of your employment history including your latest T4 slips, Notice of Assessments, and pay slips. Due diligence in the beginning will save you time and effort.
Using a simple online mortgage calculator IS NOT ENOUGH to assess what you will be approved for when it comes time to satisfy your financing condition.
Doing all of these things before making any offers to purchase property will help you find a home that is within your price range and will keep you from potentially overpaying for a property in cases where emotions are running high.
If you have any questions or would like further explanation about the financing clause, please contact me at steve@stevewalsh.ca
Special thanks to Kiley Walsh, Mortgage Development Manager at National Bank, for his added perspective on this topic. Kiley can be reached at k.walsh.nbc@videotron.ca
