In the last ten years we have bought a lot of real estate, which means that we have dealt with multiple lenders. We’ve learned all sorts of lessons about pretty much every aspect of real estate investing but the one thing we figured we had down pat was the process of obtaining a mortgage commitment from the bank. Recently we discovered, to our astonishment, that a commitment isn’t as rock-solid as it sounds. In fact, the document is pretty much misnamed. But first the story.
Imagine that you find a 4-season property on a premium lot in a sought-after cottage location at a significant discount below market value because the owners live out of the country and they’re desperate to sell for personal reasons. MPAC has valued the property at more than $200,000 above the asking price. Comparable properties peg the market value at, conservatively, $50,000 – $100,000 higher than the asking price.
You go in with a low-ball offer and to your surprise the vendors sign it back without even countering. How often does that happen? If you guessed once in a blue moon you’d be right. So you’re thrilled by the opportunity. You have the place inspected and apart from the usual list of little items that could use some attention at some point – though nothing is pressing – you’ve got a great place on your hands. The major elements are sound, the upgrades are lovely and the whole thing is in good shape. So far so good.
Enter the lenders
The lender asks for the usual forty pounds of paperwork to prove that you earn what you need to and that you don’t owe too much, but that isn’t a problem because you’re in great shape financially and everything is in order. The lender comes back with a mortgage commitment for a 2 year term – can’t beat that rate – and a 30 year amortization. You’ve asked for the 30 year amortization because this is going to be a rental property and you want to minimize the monthly costs. You’ve crunched your numbers and the 30 year amortization gives you a good positive cash flow buffer.
You supply all the documents as requested and the lender confirms that they are just waiting for the appraisal in order for them to declare that your file is complete. No problem; you expect this.
It’s what happens next that throws you for a loop: One week prior to the closing date, the mortgage agent emails to say that you need to come in and sign another mortgage commitment because the lender “had to make some changes”: They are withdrawing the 30 year amortization and changing it to 25 years. Apparently the appraiser came back with a report saying that the subject property has an economic life of 25 years. Your lawyer suggests that the appraiser expected you to have a 25 year amortization and therefore chose that as the magic number for the economic life of the property.
What about the commitment?
But wait a minute, you have a commitment right? You call your lawyer to discuss this. How can they just change the rules one week before closing? The lender has had the appraisal for more than one month and now one week before the closing they decide that the information poses a problem? Plus, this is a two year term. The property clearly isn’t going to fall down in two years. There is no clear or obvious reason why the amortization needs to change. And back to the fact that you have a commitment – can they just change their mind like that?
As it turns out, yes they can. Because every single lender has a back-out-of-it clause somewhere in the commitment, or they refer to clauses listed on their website that state that they can change their mind at their discretion whenever they like.
In a Crocodile Dundee moment akin to “You call that a knife? That’s not a knife, this is a knife!” your lawyer tells you the story of a client who discovered on the day of closing that the lender had changed its mind and would not be funding the deal. Apparently they decided that the client was too risky, and they figured that out on the day of closing.
-So why do they call it a Commitment then if they can change whatever they like whenever they like at their sole discretion? That’s hardly a commitment.
-I have no idea but it happens more often than you might think.
And there you have it. When you obtain a mortgage commitment from a lender, think of it more as a Mortgage Proposal in which they propose to fund your deal according to certain parameters but as in any proposal things could change. If they pull your credit bureau report on the day of closing and they don’t like what they see, you may be in trouble. Or, as in our case, if the appraiser decides that the property has 25 years of economic life left rather than 30 years, the amount you have to pay every month will go up.
Bear that in mind the next time that you get a mortgage commitment. You will know that it’s a true commitment when the funds have been disbursed on closing day. Until then, keep your fingers crossed and be sure to have a Plan B in place.
Do you have a story about dealing with lenders? If so we’d love to hear it. Please share below.