Losing Mortgage Loan Approval: Seller Bailout Trouble

by Meg from Fort Pierce, FL and Tom from Denver, CO

Ask Kate about mortgage loan approval in regards to seller bailout, non-arm's length transaction, and due on sale clause: Meg sailed through pre-approval with flying colors. However, once the underwriter saw the seller's late house payments, the transaction was considered a seller bailout. Complicating matters, the seller was her father-in-law, making it a non-arm's length transaction.



In the comment section, you'll hear from Tom who inherited a house and asks if the due on sale clause will require a refinance to pay off the current mortgage.

Ask Kate: Non-Arm's Length Mortgage Financing with Seller Bailout

By Meg from Fort Pierce, FL

Losing Mortgage Loan Approval: Seller Bailouts
Hi Kate...

Here is our situation.

My husband and I would like to buy his father's house. Unfortunately, Seller is more than 30 days late on his mortgage. All lenders are viewing this as a bail-out.

We do have a contract on the house. Price had to be agreed upon by Appraisal, Sellers, Buyers, Realtor, and Judge (due to the seller's divorce). Definitely, there's been no discount here.

The house is not in short sale. The first mortgage has a principal balance of $38k and the HELOC has a balance of $30k. Purchase price of house is $251k.

There is no risk on any part, except for the new mortgage we would be receiving, in which we have been already been approved for. Our mortgage was denied because of the related party being behind on mortgage payment.

Any guidance for us?

Thanks,
Meg

Ask Kate at Get-Your-Best-Mortgage-Rate.com
Kate's Answer: Non-Arm's Length Mortgage Financing with Seller Bailout

Hi Meg,

You must be frustrated after going through the pre-approval process to lose the final mortgage approval, especially after a judge has approved the transaction including the sales price.

Losing Mortgage Loan Approval: Non-Arm's Length Mortgage Financing


Hopefully, your loan originator explained that your home purchase is non-arm's length. Simply put, this is any real estate transaction between interested parties, for example, when a parent is the seller and a child is the home buyer. Even when a real estate agent sells his home to a home buyer, it is considered a non-arm's length transaction.

Why is non-arm's length so dreaded by lenders? They fear that there are secretive terms that wouldn't occur between non-interested parties and that these terms will put the bank's investment at risk.

So while you and your husband passed through the pre-approval process with flying colors, once the underwriter discovered you were buying your parent's home, all bets were off, as you've found out.

Losing Mortgage Loan Approval: Seller Bailouts


Additionally, the mortgage company saw that the seller is having trouble making his mortgage payments. Most reasonable home buyers would ask why this is a problem. After all, the seller's mortgage is being paid off. What could be the problem with that!

But if you were to climb into the bank's head (a scary place so don't stay long), you'd see a common suspicion is that the buyer is financing the home to bail the seller out of foreclosure. In similar cases, home buyers have turned houses back to sellers, making them responsible for the mortgage financing. Often, the bailed out homeowner still cannot afford the home which resulted in an early foreclosure on the books of the new mortgage lender. Not good!

Thus, if you haven't yet climbed out of the bank's mind, you've substituted the term seller bailout with bubonic plague.

Don't Give Up on Your Mortgage Loan Approval: Using Total Disclosure


Even so, here is my suggestion. Don't give up! Instead, take the time to write a letter to the underwriter spelling out the strength of your financial profile. I know your file is sitting on her desk. But it's safe to assume she's busy. So spell it out in an easily readable format, leaving nothing to guesswork.

If they give their permission, do the same for your in-laws. Because your transaction with the seller involves a non-arm's length relationship as well as a suspected bailout, the underwriter needs to be assured that there are no undisclosed terms. You could even agree to pay for another appraisal in order to confirm the house is not being overvalued, a common issue that underwriters fear will result in seller kickbacks.

Likewise provide details that confirm you won't be turning back the house to your in-laws. For example, is your house for sale? Are you moving out of a rental house? This points to needing the in-laws' house to live in as your personal residence. Likewise, you could document where the seller is going to live after the sale of the house.

Try to back up the details in your letter with documentation, for example, a purchase and sale agreement showing you are selling your home. If your in-laws will each be renting, they could offer their rental agreements as well as the divorce decree.

There are no guarantees this will restore your mortgage loan approval. But I can show you another Ask Kate letter from a couple who were turned down for a similar reason and now own the house!

Be sure to read the whole letter including the comments (near the end of the page) where they describe their success... Mortgage Loan Approval for Non-Arm's Length Non-Seasoned Home Purchase by Getting Worried.

Example of Successful Non Arm's Length Transaction


The odds were against me when I originated a home loan for a single mother who wanted to buy her ex-boyfriend's house. Complicating the matter, he asked to gift her the downpayment from his equity in lieu of future child support.

Not surprisingly, she'd been turned down by a major lender before coming to me. It's a cool story with an excellent ending. Be sure to read it... Non-Arm's Length Transaction Home Loan Help by Levi in New York.

Best wishes,

Ask Kate

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Inheritance and Due on Sale Clause
by: Tom H from Denver, Colorado

When a person dies and they have willed a property that still has a mortgage does the inheritor have to pay off the remaining mortgage at once and in full to acquire the property?

Or can the owner of a property, with a mortgage, gift that property to someone and they can continue to make the mortgage payment on the same terms?

Hi Tom, Kate here... Due on sale clauses, contained in the majority of mortgage documents in the United States, allow lenders to call due the full balance of a mortgage upon sale or transfer of property ownership. Whether the lender will continue to accept house payments from the person who inherited a property will depend on their due on sale clause policy.

Although the lender does have the right to require full payment, they are not obligated to act upon the due on sale clause. Should an inheritor hope for the best and continue making payments, it seems prudent to have a plan B in place. Here are 3 ways to compare mortgage lenders and interest rates.

Best wishes, Kate

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