The 3rd C is for Collateral. Is your house worth the price?


Collateral, Part 3 of The 3 C's of Lending

The third C is collateral. When you are applying for a mortgage, the collateral is the house. The lender wants evidence that the house you are buying is worth at least the amount of money you are paying so that the mortgage loan is almost covered if you default.

Location, location, location. What does that mean to your lender? The lender can NOT ever discriminate against a particular neighborhood in their service area. That is called redlining and is against the law. But there may be areas of your town that are unsuitable for long term mortgages for other reasons.

Is the area in the EPAís SuperFund area? Is there a safe source of water? You may still be able to borrow money to buy a home there, but there will be Iís to dot and Tís to cross. What about changes in the neighborhood? Is the commercial business use increasing and taking over the homes there now? Is the zoning changed or changing?

You can not generally get a residential mortgage for a property you intend to use commercially. That doesnít mean you can never ďbuy and live above the storeĒ, but it does mean there are more guidelines and rules as well as more hoops to jump through.

What is the appraised value? One important aspect of location is this: the appraisal must be based on comparing your property with similar properties in the same general area, which is defined as being within 1 mile or less. This is a guideline and can be exceeded if there is a good reason, but the fact that the house is a unique style in an otherwise commercial area is not a good reason.

The lender and appraiser will both look at the information available about the property. The actual inspection may not take very long and should not be substituted for a condition report if you are worried about things like the structure or the mechanicals. The appraiser is not a home inspector and is there to determine whether or not the estimated value will support the purchase price.

What if it appraises for more? Or for less? Mortgage fraud issues often involve inflated property values. This is the reason the lender and appraiser will look harder at the whole transaction if you are paying substantially less for a house than itís worth.

These are the questions the lender will have about the transaction: do the buyer and seller know each other? Is there an undisclosed relationship? Is there a kickback of the downpayment involved? Is there anything suspicious about the sales contract or is there a reasonable explanation. Maybe this is a distress sale or an estate offering. There might be a long-standing lease purchase option that a tenant is exercising. Just be prepared to explain if there are circumstances the lender is questioning.

If the property appraises for less than you agreed to pay you might be able to get out of the deal. This is why Sales contracts need to have a financing contingency or an appraisal contingency written in. If there is no contingency, you might be sued to complete the transaction.

The lender will base the loan amount on the sales price or the appraised value, whichever is less. The rest of the money will have to come out of your pocket. If the contract was written to protect you, then this is when you renegotiate the price or drop out of the deal.

The condition of the property is important. You might be looking for a fixer-upper, but beware of these hidden pitfalls. Lenders want properties that are in average or better condition. There will probably be conditions on your loan approval that require certain repairs or improvements be made before closing if they affect the soundness, the safety, or the sanitation in the home. Items that are rated Fair or Poor by the appraiser might have to be brought up to average before you get the loan money to complete the purchase.

Look for all 6 parts of The 3 Cís of Lending.

Copyright, Judi M Moore, 2rhouse.org, June 15, 2005, all rights reserved