In our hot market, screening prospective buyers may not seem crucial at first glance, but you won’t want to accept an offer if the buyer will back out later, or if the financing for that buyer will fall through.
Home Selling Motivation
The motivation for selling your home will be a substantial factor in determining the kind of prospective buyer you are looking for. For example, if you need to sell your Silicon Valley home because you have been offered a job in a new state, you may be willing to look for a broader range of buyers than if you are selling in order to buy a bigger home. Someone selling a home after the death of a loved one will have different wants and needs than a seller planning a 1031 exchange.
Likewise, a prospective buyer looking for an investment property may want (and offer) different things than one who is looking for a home for their family. There are many types of buyers with many different motivations and financial backgrounds, and often a buyer with a 10 percent down payment can be just as good as an all-cash buyer. In fact, due to our astronomical prices in Silicon Valley, we are seeing a surprising number of less than than 20 percent down loans.
While all sellers would like to see the top-dollar for their home, determine early on what your other priorities are. Do you need a fast sale or a rentback? Do you have strong emotional ties to the home you are selling, and would that affect your preference between a developer or an aspiring homeowner? Talk with your agent about your wants and needs from the start so you can plan how to improve your chances of getting strong offers from your ideal buyers!
Conventional Financing and Your Prospective Buyers
When selling your home, you will likely be familiar with some of the basics of financing based upon your own experiences as a buyer. However, there are some important aspects of financing about which you should be knowledgeable to ensure that your perfect prospective buyer can actually afford your home. How the buyer intends to pay for your home, and whether or not they are qualified for financing, is really the most important aspect of the entire sales transaction. We all know that without the money, there is no sale.
There are three primary sources for financing the purchase of a home: banks and credit unions, mortgage bankers and mortgage brokers. Most people are aware that banks and credit unions loan money for home purchases, including the former Savings and Loan associations. Savings and Loans, banks and credit unions lend money directly to the buyer from their own pool of funds, usually based on customer deposits. The individuals that work for the bank are usually called loan officers. Loan officers are often paid commission in addition to their salary, which provides their incentive to get loan applications.
Mortgage bankers are also direct lenders and use their own funds, or those of wealthy investors, but they usually do not keep the loan. They will often sell off the loan to a government-sanctioned major home lender like Freddie Mac or Fannie Mae. You might not even know if your loan is sold off, as mortgage bankers often continue to service a loan by mailing statements and collecting payments.
Mortgage brokers shop around for buyers of loans, searching for the lender with the program or interest rate that fits their client’s situation. They take the application and can apply to dozens of lenders like banks and mortgage bankers, and act as intermediaries between borrowers and lenders. They can’t control interest rates or terms and are usually paid by both the buyer and the lender through closing fees or points. The points paid to buy the loan are often the same as going directly through the lender. One point equals 1 percent of the loan amount. Regardless of whether a buyer uses a broker or a banker, the key is making sure that your buyer has obtained financing prior to making an offer on your home.
Prequalification, Preapproval, and PreUnderwriting
The terms prequalification and preapproval are often used by buyers and their agents, and it is extremely important that you know the significant difference between them. The difference is like thinking you can afford to buy a home as opposed to having the bank say you qualify.
A prequalification letter says the buyer earns enough money to buy a home in a certain price range. Unfortunately, this is based on information given to a bank or mortgage broker by the buyer over the phone. The lender may not have verified the buyer’s income or run a credit report. Therefore they do not know if the buyer’s credit is wonderful or terrible, or if they can secure a loan to fit the buyer’s budget.
Obviously, you want to make sure that the prospective buyer is not just prequalified to buy your home, but that they are actually preapproved!
If a prospective buyer has a preapproval letter, the lender has checked the buyer’s credit, gotten basic information on their income and debts and knows approximately the size of mortgage the buyer will qualify for. Based on the verification, the buyer would be approved for a loan. A real preapproval means that the buyer’s loan package has been submitted to a lending institution and has been approved. The only things needed to complete this loan are a purchase agreement signed by buyer and seller, a preliminary title report, and an appraisal. (Be advised that some lenders may generate a preapproval letter when really a prequalification letter should have been written. You or your agent should be able to ask a few questions and verify the actual status of the buyer’s application.)
Many lenders also perform “desktop underwriting.” If the buyer’s credit is good enough, and if it appears their income and debt ratios are strong, the lender can submit a loan application immediately by computer and then receive, almost immediately, an answer from an underwriter. Usually, it will come in the form of full loan approval up to a certain amount, subject to an appraisal of value on the property or with certain conditions that have to be met, such as verification of the information submitted. This is, of course, the best kind of information to receive from a buyer.
Financing Deadlines for your Prospective Buyers
Right now, our pandemic driven seller’s market is so extreme that we see few sales which include any contingencies. But that doesn’t mean there won’t be loan or appraisal problems that could impact you negatively. For this reason we still must screen carefully.
When you enter into a contract with a buyer there will likely be a deadline by which they must have full loan approval. If they do not obtain full loan approval by the contract deadline, with a contingency the buyer may terminate the contract. Without it, which is more likely today, they may be scrambling to find alternate financing and that will delay the closing – at best.
Another deadline to watch is the length of time for which the buyer’s loan is locked. A short lock period and a long escrow can be a bad mix! Early in my career, I once had a 90-day escrow, but the loan lock was a bit shorter. Unhappily, though all contingencies had been removed a month before, at the end of the escrow the buyer’s interest rate jumped up and the buyers no longer qualified for their loan! The house did not close escrow at all. Most escrows here close in about 30 days, though some go to 45 or 60. Just make sure that the loan lock time frame is as long as the escrow period.
Right now interest rates are rising, so be aware that most buyers will want a short escrow so that they do not have to pay for a longer loan rate lock.
Creative Financing: A Path Forward for Prospective Buyers
Because of the astronomical cost of housing in San Jose, Los Gatos, Saratoga, and surrounding areas, some buyers are choosing non-conventional loans so they can get their foot in the door. This is not easy in a seller’s market, but when a home’s been on the market for more than a month and multiple offers are no longer anticipated, this may be a viable option.
Some of these buyers borrow a relatively common amount (i.e. 80%) with a hybrid product, which is fixed for a certain number of years (three, five, seven, or ten), and then the loan becomes adjustable. Some borrow a conventional percentage but do it “interest only”. Another combination is the 80-10-10: with a 10% down payment, 10% second loan and 80% first mortgage which borrowers might use to avoid PMI (Private Mortgage Insurance). Others buy with 100% financing.
Move-up buyers might get credit lines on their current home as a down payment in addition to a regular first loan; then, after they complete the purchase, they sell their first home and pay off the credit line. For families with small children who are in overcrowded homes, this can be a better alternative then selling first, while still in the home. There are some other financing products available that will help them to move just once (but of course there’s always a cost).
Some ideas our real estate borrowers like are the NIV or no-doc loan, also referred to as a stated income loan. With enough money down, usually 20 percent but sometimes only 10 percent, buyers can get one of these loans. NIV stands for “no income verification,” and designates a loan where the lender feels secure enough with the size of the down payment that they don’t concern themselves with verifying the income stated on the loan application. The lender may simply verify that the buyer is employed and that they actually have the resources necessary to cover the down payment and closing costs. A no-doc loan is a loan where the lender does not require documentation of either income or assets (assets in this case being the money to cover down payment and closing costs). Both of these loans will have a higher interest rate, as much as 1% to 2% higher than conforming loans. But when buyers can’t secure normal financing, these are still good loans to go after. Finally, many of these loans went away after the Great Recession, but are back again, albeit with more stringent guidelines today.
Many Realtors® have also identified certain people who have money to invest, and who would like to earn somewhat more than the prevailing 30-year Treasury rate. For 1 or 2 percent above the current 30-year rate, they are often willing to finance a smaller mortgage themselves. Sometimes such loans have balloon payments, meaning that after a period of smaller payments (perhaps five years), the entire amount becomes due. For people who have had credit problems but can demonstrate they are making efforts to clean up their credit, a loan such as this will often get them to the point where they can get conventional refinancing long before a balloon payment becomes due. When a buyer has very little cash to put down, a private lender may take other collateral instead, such as cars or business equipment.
In the past, I’ve seen sellers carry back a note for 10% of the value of the home for 5 or 7 years. For them, it was a plus that the prospective buyers had a path forward for purchasing the home, and the added bonus is that the interest rate was considerably higher than they were getting at the bank.
There are many types of creative financing which your prospective buyer may want to use. When you are looking for the right buyer, knowing that they have secured financing, even if through unconventional means, will ensure that your sale will be successful. Sometimes it’s the only way to make a deal work, and if so, you shouldn’t be afraid to sell to someone who is using creative financing. Just make sure you ask a lot of questions and have your Realtor® at your side.
Mary knows the real estate business. She excels at every aspect of a home sale: property preparation, staging, seller protection, advertising, closing and getting the best price. She is conscientious and works very hard to get the job done efficiently. I give her my highest recommendation.