Why Do Purchase Escrows Fall Apart? (And Why Is It Happening More Often?)
There have always been real estate transactions that fall apart. The reasons why they fall apart are as varied as the people who enter into the transaction in the first place. Let's get back to the very basics for a moment. An offer to purchase is a representation that a given prospective buyer would be at least willing to purchase the property on the terms you are offering. Accepting that offer to purchase means that the seller is at least willing to sell it on the same terms that the buyer is offering to buy upon. If one or the other of these parties is not willing to consummate the deal on those terms, why was there both offer and acceptance? There was offer and acceptance, or there isn't anything more than negotiations to fall apart. People fail to reach agreement all the time. That's not what this article is about. It's about what happens to prevent the transaction from being completed after you have a valid contract.
The last credible figure I heard was that 50 percent of all escrows in San Diego County are falling apart. This means that one out of every two contracts don't happen. A few years ago, the proportion was a small fraction of that - I can't find it online, but I seem to remember 11%. This increase is both outrageous and preventable.
The first reason transactions fail is new information. It isn't cost effective or a good negotiations tool for a buyer to spend money on inspection and appraisal before there is an acceptable contract. When this information comes in, you can expect there to be a reassessment of the transaction, because you can expect there to be something about the property that does not conform to reasonable expectations. I certainly can't remember any transactions I've had where the inspections didn't reveal anything new. I've had them where what was revealed was trivial enough to ignore, but never a one where there was nothing. Transfer disclosures from the current owner to the prospective buyer are another of the possibilities for new information to crop up.
All of this new information can indicate a need to subsequent negotiations when it comes to light. If the buyer thinks it's small enough that they are willing to accept the transaction "as is", they can choose to let the transaction continue on the track it's on. If it's big enough that they're unwilling to deal with the situation, they can also choose to walk away. The vast majority of the time, the sanest response is some new negotiations based upon the new information. This isn't normally about things like overall sales price, it's about getting the property into the condition and functionality that the buyer thought they were getting in the first place. Either party can be obstreperous and unreasonable at this point, effectively killing the transaction.
There's also the issue of cold feet, and the related issue of "grass is greener" syndrome. Either one can apply to either party in the transaction. In the first, the buyer decides they don't want to buy or the seller doesn't want to sell after all. In either case, they weren't really "sold" on the benefits of the transaction to them. "Grass is greener" is where they still want a deal, just not this deal. Those happen when markets are asymmetric in power. A few years ago, it was sellers who wanted to bail out of contracts they had duly negotiated because someone offered them a higher price. More recently, it's been buyers trying to pull out because they think they've found a better deal somewhere else. Both are vile. It's not a sin to want the best possible deal, but once you enter into a legal contract you should be prepared to honor your representation that you want that deal. Both of these phenomena are the fault of poor agents, and both are a good way to waste a lot of money in legal expenses when their clients are sued for specific performance. I don't want any part of agents that don't take appropriate steps to prevent either one of these in their clients, and I take note when I hear about them. It's also a reason not to take an attitude of "no quarter!" in negotiations. My client signed that offer or contract because those terms will make them happy. If the other side decides they need to bail out because the terms are odious, my client isn't happy.
Closer to the point is ability to perform. This can be a seller who can't or won't or doesn't meet their obligations in a timely fashion. Delivering good title to the buyer is kind of important to the transaction, and it does occasionally happen that the seller can't do this. Or they don't have the money to make needed repairs, or just won't get off their backside to actually do it.
But far more commonly, it's the ability of the buyer to perform their obligations under the contract that kills the transaction. I have heard about occasional buyers who couldn't or wouldn't or didn't perform on other scores, but the most central of these in the current market, and the reason for at least 90% of the rise in failed transactions, is that the buyer cannot qualify for the necessary loan.
The Era of Make-Believe Loans is over, but judging by the evidence, there's an awful lot of people who haven't figured this out yet. That's the first thing I want to find out when I get a new buyer into my office: What's the evidence of their ability to qualify for the necessary loan? How much do they make, what are their other payments, what is their credit score, how much do they have for a down payment, and is there anything about their situation which might be a cause for concern during the loan process? I don't want to give them the third degree, but I want to be confident I'm not wasting their time or mine, and that I'm not setting them up for a failed transaction. Failed transactions don't make clients happy, they waste the client's money, and they aren't any good for my business, either.
A year or so ago, if somebody came into my office with a 580 to 600 credit score and two years in the same line of work, chances were excellent that a loan could be done - even 100% financing. That is not the case currently, and the time to plan the loan is before the clients fall in love with the property they can't afford.
Lest I be unclear, 100% financing isn't completely gone, but you have to plan more carefully now, and often the purchase contract must be written in certain ways to make it acceptable to everyone who needs to be involved. Write the purchase contract wrong, and you might have killed the deal before it begins because there's something there that's not going to be acceptable to the lender, and sometimes it can prevent other folks from signing off on the deal as well. Furthermore, if the required steps in the contract are going to cause the seller to balk, you're better off finding out before you've got a contract.
The loan environment, especially for loans above 80% loan to value ratio, has changed drastically in the last year, and all of the changes thus far have been in the nature of making qualification more difficult. In my area, appraisal values are arbitrarily reduced by all lenders I'm aware of currently, and if you're not careful, you can find yourself in a situation where 85% loan to value is the maximum that can be done (This just changed - see below). Since the proportion of buyers that have that kind of down payment is rather small, and the proportion of those who want to invest it in the property if they do have it is even smaller, that can be a problem.
Even the government programs like VA and FHA with their low down payment requirements have their stumbling blocks. Not only do they require a buyer to qualify via full documentation of income (as do ALL government-based loan programs), but there are subsidiary requirements as well. Some properties are not eligible, period. Some people (and some companies) can't be involved, period. Investment property and second homes are iffy to doubtful with the VA and practically non-existent for FHA. It's a real good idea to know if you're going to hit one of these roadblocks before you are sixty days into a transaction that's not going to happen, and now we're all going to pay lawyers to fight over the deposit.
When I list a property, I want real information that tells me a loan is doable for this borrower before I advise my client to accept a given offer. Pre-qualification is a joke and even pre-approvals aren't anything to put stock in. The only examples of either that I trust are ones that I wrote, because I know what went into them. However, Steering is illegal. I can't require the buyer to get their loan through me or even to talk to me (or anyone else of my choosing). What I can do is require their loan officer fill out my form and provide documentation that enables me to determine whether a loan is doable or not. If I can't find a lender that can fund that loan, we've got a problem. It's kind of important to know this before we counter.
Unfortunately, we've had ten years where loan money was easy to get, no matter how ridiculous the transaction, and it's left a very strong imprint on many agents. Many have literally know no other environment, and they're finding it hard to make the necessary mental changes. I haven't been in the business ten years, either, but I do understand how the loan environment has tightened up and its effects upon my clients. Even the agents who have been in the business much longer may have no real grasp of the loan environment and often they're just checking off the box that says, "pre-qualification" on the checklist because that shows they did their due diligence. That isn't going to fly anymore. It may or may not help them when they're defending against a lawsuit, but it certainly isn't going to make their future ex-client happy about the thousands of dollars they lost, either because they couldn't qualify or because their prospective buyer couldn't.
When will we see a loosening of lending standards? I don't know but I wouldn't be surprised if it happened today (Okay, I was a little bit surprised when the email that was the first official notice from any lender came in as I was typing this paragraph! This will make it easier for properties that don't qualify FHA or VA to sell). It isn't important, because we're not going back to Make-Believe loans any time soon. Be careful before the contract, and you'll have a lot less chance of getting bitten by the obstacle of a loan that cannot be done.
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