Subject Free? Perhaps Not.
Short Version:
- Stellar credit, tremendous equity, and strong documented income are not enough to guarantee financing approval. The lender must approve of the property as well – and there is more than simply value reviewed.
- Lenders reserve the right to change debt servicing formulas after issuing a client’s pre-approval – an existing pre-approval will not be grandfathered. No specific written notice is offered either.
- Outbuildings do not count in appraised value. That $500,000 barn, the $150,000 workshop, the $250,000 carriage home… sorry. Not part of the lending value.
- What you plan to do with the property matters little. It is all about what is, not what will be.
Bottom line, ‘SUBJECT TO SATISFACTORY FINANCING’ is a key clause in every offer written. Do not take chances with a subject-free offer unless you have either the cash to close without financing or a detailed strategy in place with an experienced Mortgage Broker.
Long version:
We are now entering what feels to people in the industry like our 25th ‘June’ in a row: two years of each month being crazier than the last. Crazy busy, crazy prices, crazy-crazy.
As an applicant, you may be bulletproof, and you may be feeling pressured to go in subject free, but there are many pitfalls you need to be aware of. Most can be avoided with some prudent, proactive, and experienced guidance.
Ask your Broker how many subject-free offers they have been involved in, and ask how you can best prepare in advance to go in subject free. There are a variety of topics to cover. I will touch on only a few in this post.
1. Documentation
MLS Listing
Ensure that you are getting a copy of the MLS listing to your Broker in advance. The MLS notes can raise red flags and terminate an application before a lender even looks at the rest of the file. Comments in the notes such as these will all be problematic:
- remediated grow-op
- builder’s dream
- subdividable
- bring your renovation ideas
- fire damage
- water damage
- undergoing insurance repairs
- three complete kitchens in the basement
Lenders want to finance simple, long-term housing purchases.
Lenders do not want to finance fix-and-flips, renovictions, subdivisions, major renovations or remediation projects, flop-houses, etc.
It takes a lender 18–24 months to recover the cost of placing a mortgage; they want stability.
Property Disclosure Statement
This is another key piece to be reviewed in advance of your subject-free offer, and not reviewed by just yourself and/or your Realtor.
A property disclosure statement that refers to the following sorts of things will end a file with a lender instantly:
- Pending litigation
- Pending special assessments
- Incomplete major repair work
- Vermiculite insulation
- Unapproved renovations
- Unauthorized accommodations
- Wood-burning stove
- Lease in place for X more months (on an ‘owner occupied’ purchase)
The list goes on… and on.
Again, it is about the state the property is in right now, not the state that it will be in at some point in the future. Your plans do not factor in as strongly as the current state of the property. And as you can see from that list, things you might think are of no matter can be of major importance.
2. Policies and Guidelines
To some extent it can certainly be argued that logic has been removed from the mortgage approval process.
Over the past few months, as with the past seven years, steady changes to lending guidelines have continued, many changes public, many unannounced.
Three examples:
- Policy changes that make media headlines
- Changes that fail to make the news, but do make it to the inboxes of Mortgage Brokers and bankers
- Changes that lenders make internally without formal notice to any party, to be discovered only once tripped over
As you can imagine, the last of the three creates the most significant challenge to Broker/client relations. Compounding the issue is that such changes are often nuanced and difficult to articulate. An example is rental income calculations ( X% addback vs. X% offset vs. DCR worksheet vs. T1 General net rents) as applied to either the subject and/or non-subject properties.
This last sentence was meant to be awkward, as explaining each of those terms and acronymns is another 500 words which I will spare you. But it makes the point. Complex changes within already complicated policies containing arcane definitions do not make for a clean 20-second soundbite for the news. And so they slip in silently.
A little bit more about each of the types of changes we are seeing.
- A) Policy changes, which do make headlines
A recent example was the announcement regarding changes to down-payment calculations on insured mortgages (purchases with less than 20% down between $500,000 and $999,999.99)
Click here for the full story.
Google alerts has filled my inbox with headlines on this topic, which ultimately is unlikely to have a dramatic impact on my clients’ lives – or really any individual clients’ lives. It will affect under 4% of buyers in a material way.
So it’s a non-story for the 96% of buyers… apologies for the additional attention.
- B) Broker notice-only guideline changes
These changes are not deemed media-worthy as they are frequent and complex in nature. They often flip-flop, and exceptions are occasionally made. Again, such changes often apply only to a small percentage of new mortgage applications.
They are newsworthy only to the handful of clients affected.
One major chartered bank recently announced they would no longer be accepting mortgage applications from clients that own more than five properties. Note that it is purely about whether the applicant owns five properties, not whether they have mortgages on them, or wish to mortgage more than one. More than five properties owned? Please keep walking.
It is perfectly understandable a why the media do not seize on such changes. They affect a small number of applicants and are not very exciting.
- C) Internal memo guideline changes (a.k.a. landmines)
The most insidious of all changes made to lending policies is the unannounced change. These are truly challenging to deal with. They lie in wait like landmines, only to be discovered the hard way: by Broker and client in the middle of a transaction.
They include but are not limited to;
- More detailed review of strata minutes (key words: water, leak, membrane, building envelope, engineer, special assessment, etc.)
- Strata depreciation reports, or at least the vote results
- Deviation from CMHC and other insurers’ approved policies: ‘The insurer will allow it, however we (the lender) no longer will.’
- Holding companies no longer allowed on title with all but a very few lenders
- Restrictive and inflexible appraisal review
- Dividend income no longer allowed.
- Remediated grow-ops no longer approved
- Lease land properties no longer approved (native and government)
- Co-op properties no longer approved
- Financing of undivided interests no longer approved
With each passing year a Broker’s job grows more difficult. Luckily I like a challenging environment, so yippee – lucky me. The most difficult role in the transaction is that of the client. The client is along for the ride, one hopes with a skilled Broker behind the wheel and with clear communications between all parties.
Is all of this bad news? No not at all. The market will keep moving, things will keep happening. It just requires a few more advance steps to stay safe amidst the craziness.
Bottom Line for Brokers: We need to have detailed pre-approval conversations leaving clients clear that a review of the property is vital for FULL approval. We need to review all related client and property documents before an offer is written.
Bottom line for Clients: ‘SUBJECT TO SATISFACTORY FINANCING’ is a key clause in every offer written. No matter what the Broker or banker say, think hard about writing a subject-free offer unless you have the cash in hand to close without financing, because new hurdles are popping up faster than ever.
Clients would be wise to minimize risk, by either writing offers that contain a ‘subject to inspection’ and/or a ‘subject to financing’ clause, or by having a detailed conversation with a skilled Broker well in advance of writing a subject-free offer.
There is a technique for going subject free with next to zero risk, but that is part of my secret recipe. It is a case-by-case conversation, not a blog post.
Thank you.