Last October I referenced a piece by Scott McGillivray called the “Top Ten Ways to Win a Bidding War”. As we head into the spring fever activity that usually erupts in real estate markets across Canada, here’s a reminder of some things NOT mentioned in the article…
1) Appraisal shortfalls – the article’s first “way to win” is to crunch the numbers, ideally with a mortgage finance specialist, and to get a pre-approval. It then goes on to caution against over-bidding because of the potential impact on monthly carrying costs (in their example, $85 month). What is far more important for homebuyers to know is that pre-approvals only qualify the borrower – not the property!
A more frequent problem – and one that can be far more difficult to solve – is the value that a lender uses for financing. A home that sells for 20% over asking ($600k instead of $500k, for example), may not appraise even close to the purchase price. If you qualified for financing at 10% down of $600k, you can still afford the payments; the problem is that the bank will only lend on the lower value, leaving you to make up a massive downpayment shortfall. In this example, you’d need to come up with $160k as a downpayment, rather than $60k as planned – an extra $100k (assuming you even have it) that could be paying for your closing costs, moving, and renovations. This scenario often pops up with “as-is” purchases where significant renovations or demolition is required.
Every problem has a solution, and a lot of buyers that face appraisal shortfalls find the extra money in gifts from families, investments, or unsecured credit lines. It may also mean getting co-borrowers or guarantors, or straining the finances of others. If you don’t have a financing condition in place, you may get the home; but if you face an appraisal shortfall, you could face a huge problem. What if you had planned to make repairs, or if the furnace breaks down, or the leaking roof was cleverly hidden by a fresh coat of paint during “staging”? All that cash is now tied up in your home – or may not even be available at all. Which takes us to number two…
2) Locked Downpayment. If you are getting your downpayment on your new home from the sale of your current one, don’t be so quick to present a “clean offer”. We first looked at this in the fall of 2012, and since then there has been a steady trend in deals falling apart at closing because the buyers’ current property – often a condo – aren’t selling, leaving them with no liquid assets to close their next purchase. In some cases, clients have had to take out extremely painful second mortgages, or even worse, not closed the deal at all (even months later) because they couldn’t come up with the cash. There are ways to work around it, but they can be costly and can sometimes lead to the third problem…
3) Deposit Risk. A serious offer benefits from a serious deposit, but there are cases where your deposit may be at risk if you haven’t properly prepared for your “win”. The past two years have seen a growing number of ‘walkaways’ at closing, where a prospective buyer, despite a firm offer and a large ($10k or more) deposit, chooses (or is forced) to walk away from a deal at closing because they cannot fund the deal. In a few cases, the reason is financing related, but in most cases it is because the property didn’t appraise as hoped (and the client can’t come up with the shortfall) or their current property didn’t sell (leaving their equity tied up and at the mercy of a buyer’s market).
There are ways to hedge against these risks, such as having a ‘gift’ resource available, qualifying for purchase-plus-improvements financing, trying to qualify to carry both properties (using the current one as a rental), or securing other short term credit (such as a line of credit) prior to looking for a home, but these may not be viable or enable you to meet lending criteria for a bank.
As we said last fall: think of it as a bidding battle, not a war. Acquiring the property is only the first step in a potentially lifelong effort to pay for and make use of your investment. The purchase is only the start of your home ownership, and there are a host of unknowns that can pop up once the purchase transaction is completed. Exhausting all of your financial resources is a HUGE decision, and when that decision gets made in very emotional circumstances, overseen by agents who need to get a deal done and move on to the next one, there are many, many opportunities for disaster.
If you end up in a situation where you could be facing a multiple offer bidding war, think beyond “winning” the war and plan out how to PAY for it. This starts with pre-approval, but also looks at planning for downpayment shortfalls, low appraisals, and other potential issues.
Let your realtor know your concerns – they have a commission, a reputation, and a time investment at stake, and need to know what you are able to do (or not do) to get a home. Approach a bidding war with caution, make sure you have strong allies – not just a realtor you can trust, but also a mortgage specialist who can work numbers accurately and on a moment’s notice – to help you along, and disclose every financial item you can think of, even if it may not seem important to you, during the preapproval process. Finally – and most realtors usually hate this – but don’t dismiss financing conditions out of hand; yes, there is a risk in not bringing in a “clean” offer, but this is a decision that affects you for the rest of your life! There’s no point “winning” a home if it leaves you strapped for cash, in over your head, or walking away from a deposit because the home doesn’t appraise or the math just doesn’t add up.
Finally, remember that pre-approval can only evaluate the borrower – not the property! You may be the ideal mortgage client, but if you are bidding over asking on a property that needs work, there is no guarantee how much (or how little) the bank will be willing to lend. Wars have casualties – on the losing side, and the winning one – so be prepared to sacrifice a lot, both now and for years to come…
borrowbetter 