WHY does ANYONE want proof of a down payment?
Why the heck would a seller want proof of down payment funds? Are they overstepping? Are they being adversarial from the start? Why don’t they trust buyers? Isn’t the pre-approval letter from the lender enough? Is the listing agent just pushy?
The best way to answer these questions and similar ones that I’ve heard floating around is to understand the finance contingency, how it fits into a contract, how it affects buyers and sellers, and how the location of the down payment funds can effect things. This is good info for buyers, sellers, and agents to gain a deeper understanding and do away with gut reactions and myths. So, read on for more because, respectfully, some people may need to calm down.
Finance contingency 101. How does it affect a buyer?
When a buyer finances any portion of their home purchase, they rely on a finance contingency to protect their earnest money deposit because they know that a pre-approval isn’t a guarantee that they’ll get the loan. There are several things that can cause a buyer’s financing to fail including, but not limited to...
Sudden unemployment
A low appraisal
A big purchase (or multiple big purchases)
New lines of credit
Assets losing value
Money that didn’t materialize
Unavailable down payments assistance program funds
etc…
The finance contingency is designed to protect the buyer and give them the time and space to ensure that they can secure the loan and close on the house, and it’s a great tool for buyers. However, buyers need to be certain of the account any cash resides in because the wrong disclosure or lack of proper disclosure can cause buyer to inadvertently breach a contract on Day 1.
A buyer’s finance contingency also invites the seller to follow the loan process, communicate with the buyer’s lender, and deliver a notice to perform that asks the buyer to waive the contingency at a set point in the contract. It’s designed to help all parties have a secure transaction. It’s not really designed to be an open ended benefit for the buyer with no seller interaction.
How does a finance contingency affect a seller?
Plainly said, a buyer’s finance contingency places the buyer’s financial risk on the seller. Through the finance contingency, the buyer asks the seller to take their home off the market, stop advertising it as active and available, and continue to pay carrying costs on the property while the buyer goes through the approximately 3 week process of applying for financing and securing the loan. If the buyer can’t secure the loan, they have the unilateral right to terminate the contract and get their earnest money back so long as their finance contingency remains in effect. The seller has no say in that. It’s a great protective tool for the buyer, but it does create risk for the seller in the form of valuable time off the market that could result in a missed window, increased carrying costs, and potential stigma.
Hidden factors related to the buyer’s finances and the finance contingency increase the risk to the sellers, and that’s why asking for proof of the down payment it important. A down payment that’s being held in a checking, savings account, or money market account owned by the buyer is liquid and ready for use, so it’s pretty strait forward. A down payment that’s currently invested in a brokerage account isn’t available for immediate use, so a timeline needs to be set for those securities to be sold and the money transferred. A down payment that’s coming from down payment assistance, from a retirement account, or as a gift from a family member is also not available for immediate use. It needs time to get where it needs to be, and there may be additional steps or guidelines before that money can be used for a down payment. Knowing where the money is helps everyone know the steps involved in using the funds and the timeline needed to do so, and that helps keep things on track and prevent unexpected delays in closing and other issues.
Hidden facts or improper disclosures from the buyer can cause them to breach the contract and put their earnest money at risk on Day 1, so a correct evidence of funds disclosure protects the buyer as well as providing transparency to the seller.
How can sellers and buyers balance the risk and reward for a more secure transaction for all?
Before a seller agrees to a finance contingency, it’s reasonable for them to request transparency in the form of a preapproval letter, communication from the lender, and evidence of down payment funds including the source of the funds, so they can make an informed decision to take on that risk. A seller asking for transparency is not being aggressive towards a buyer. They are being careful and requesting information they need to make informed decisions in exchange for giving a buyer contractual protections and the time to enact them. Think of it like a home inspection except instead of inspecting the home, the sellers are inspecting the finances so they know what they’re getting into.
How should a buyer view a finance contingency & requests for evidence of down payment funds?
A finance contingency is a huge buyer benefit that buyers should take full advantage of. However, it’s important that buyers understand that they are asking the seller to assume risk and the cost of that is transparency and timely performance. What does this mean in simple, layman terms?
Know that you’re asking the seller to assume risk.
Be forthcoming and share your preapproval and lender information upfront.
Be prepared to show evidence of down payment funds and understand that this helps the seller feel confident in moving forward and helps everyone know what needs to be done and what timelines need to be in place for the down payment to be put to use. Also, understand that this is added protection for you when done correctly.
Don’t take the seller’s request for transparency personally. Just like when you do a home inspection, they are only trying to gather information and make informed decisions.
Know that you need to work through your loan process timely because your finance contingency offers the seller the opportunity to follow up and request that you waive it at a later date. It’s meant to offer you the time that you need to secure the loan. It’s not designed to last forever.
How should a seller view a finance contingency?
Hey, great job! You’ve got a buyer! I get it if you’re apprehensive at this point. After all, I’ve mainly talked about the seller risks associated with buyer finance contingencies. However, most buyers can’t pay cash for a home, so a buyer that can obtain financing is a buyer that can buy your home. Congrats!
Now, trust but verify. Request evidence of down payment funds, work with your listing agent to get regular updates from the buyer’s lender, follow the progress of the loan, and deliver the notice to perform to ask the buyer to waive their finance contingency at the set time in the contract. Don’t sit passively through the process and wait for the sale to close or for things to fall apart. Insist on transparency, and use the tools that the buyer affords you in their finance contingency to do what you can to ensure your security and the success of the transaction. That’s not aggressive. That’s just smart business.
When it comes to the finance contingency and evidence of down payment funds, what are some reactions and myths to let go of?
The pre-approval is enough - A lender pre-approval is a solid first step. It shows that a buyer has proactively connected with a lender to determine if a loan is feasible, but it doesn’t offer full transparency or answer all questions related to the buyer’s financing or ability to close on a house. Simply put, if the pre-approval was enough, buyers wouldn’t need a financing contingency. (and before you argue that the appraisal necessitates a financing contingent, no, there is a stand alone appraisal contingency that could be used if a pre-approval was enough)
The lender already verified everything - That may or may not be accurate. It really depends on how far along they are in the pre-approval process. However, even if the lender has verified everything and the buyers are pre-underwritten, the preapproval does not provide specifics or a full picture of seller’s risk, it does not address the source and status of down payment funds, and it does not confirm that the buyer’s agent knows what type of account the funds are being held in and has helped the buyer make the correct disclosure. It’s an incomplete document.
Evidence of funds is “extra” or “aggressive” - No, gathering evidence of funds for down payments is smart. It lets the seller know if the funds are already held in a cash account that’s owned by the buyers and ready for immediate use, or if the funds are in a brokerage account and securities must be sold before they will be available, or if they are coming from a family member as gift funds, or if they are being supplied by a down payment assistance program, etc. It helps sellers fully evaluate the risk and understand the process of the buyer’s finance contingency. It’s completely reasonable for the seller to want know these things before they agree to carry risk for the buyer. It also helps protect the buyer’s earnest money when completed correctly.
People should just trust each other - Look, trust but verify is a saying for a reason. I absolutely believe that we should assume good intent in real estate transactions, but that’s not enough. We’re talking about legal documents and massive amounts of money. Every consumer has the right to make informed decisions, and no one should do business on assumptions or guesses. After all, buyers should do home inspections instead of trusting a seller’s word that everything is in good order. Sellers shouldn’t be expected to blindly trust anything either.
*Literally any pushback from agents - This one is for industry professionals. The 22EF and 22AD aren’t aggressive maneuvers against your buyer clients or you. They are simply tools that listing agents use to fulfill their fiduciary duties to their seller clients much like the inclusion of a 22A and 35 are tools that you use to fulfill your fiduciary duties to your buyer clients. We’re not battling. We are all here to help our clients understand the process, make informed decisions, and seek good outcomes. Please don’t get offended when another professional is doing just that.