Financing in Connection With a Real Estate Purchase

The financing to purchase a residential property can be either a traditional loan from an institutional lender, a purchase money mortgage from the seller of the property financed, or a hard money loan from a private lender.

Institutional Lender

This is the most common form of financing obtained in connection with a residential purchase. The loan application is based on the economic conditions of the borrower. Once this is approved, the institutional lender issues a “commitment letter”, which summarizes the terms under which the loan will be disbursed and the conditions to be satisfied before closing.

Since the contract of sale is signed and the down-payment is made before a loan application is filed, one of the most heavily negotiated clauses is the mortgage contingency, which determines whether the transaction will get to closing even if the loan application is not eventually approved. The seller will try not to make the closing contingent on the obtainment of the loan, while the purchaser’s attorney will have to reserve the right for the purchaser to terminate the contract of sale and have the down-payment returned if the financing does not go through within a certain number of days between 30 and 60. 

Even when the contract provides for a mortgage contingency, once the commitment letter from an institutional lender is issued, the purchaser will be obligated to close on the transaction, except for some egregious circumstances, such as failure of the institutional lender. However, the purchaser’s attorney should try obtaining a termination right in the event the lender is no longer willing to fund after the commitment letter because the appraisal on the property comes in lower than the purchase price. In the event of a purchaser’s willful failure to move forward with the closing, the down payment advanced at the time of contract of will be forfeited and treated as liquidated damages to the seller. Finally, the mortgage contingency clause always contains some language permitting the purchaser to close on the transaction even if the institutional lender is willing to finance an amount lower than the one initially indicated in the commitment letter. 

At closing, the financing documents will include a promissory note, a deed of trust or security agreement, a mortgage on the property, the closing disclosure plus additional documents that can vary based on the specifics of the transaction.

Purchase Money Mortgage

In a purchase money mortgage, the seller is financing (wholly or often partially) the property that the purchaser is acquiring. Often it is used to bridge the gap between the purchase price and the amount of loan the purchaser qualifies. Typically, the seller will charge the purchaser/borrower more than an institutional lender. An example of purchase money mortgage is a rent-to-own arrangement, where the tenant will have an option to purchase the property when the lease expires.

Hard Money Loan

Hard money loans are 1-3 year bridge loans offered by private lenders to borrowers that do not qualify to obtain a loan from an institutional lender. In fact, the credit strength of the borrower is not a crucial factor, while the financing is almost exclusively based on the loan-to-value (LTV) ratio between the assets given as collateral to the lender and the loan amount. Hard money lenders charge significantly higher interest rates than institutional lenders, but always within the usury rate permitted in each state (for instance, 16% in New York). Hard money borrowers are often investors that intend to purchase a property in bad condition, to do a gut renovation, and “flip” it (sell at a profit after all the expenses, including those in connection with the loan received).