Finance Clause: Detailed Overview
A Finance Clause or Finance Addendum is a part of a real estate sales contract that outlines specific provisions for securing a loan to purchase the property. The clause protects the buyer by allowing them to withdraw from the transaction without penalty if the terms specified in the clause cannot be met. This can include reaching a certain loan-to-value ratio, obtaining a specific mortgage interest rate, and more.
The finance clause typically includes:
- Minimum Amount to be Financed: The least amount of loan the buyer should obtain.
- Minimum Loan-to-Value (LTV) Ratio: The smallest ratio between the loan and the appraised value of the property permitted.
- Maximum Interest Rate: The highest interest rate the financing can have.
- Maximum Discount Points: The highest number of discount points the buyer is willing to pay.
- Maximum Origination Fees: The highest amount that can be charged in origination fees.
Examples of Finance Clause Terms
Example 1: Stan must secure a mortgage with an interest rate not higher than 5% and an LTV ratio of at least 80%.
Example 2: Maria’s mortgage must not exceed origination fees totaling more than 2% of the loan amount and must secure financing for at least 70% of the purchase price.
Frequently Asked Questions (FAQs)
What happens if the finance clause conditions are not met?
If the specified conditions within the finance clause are not met, the buyer can legally withdraw from the sales contract without losing their deposit or incurring any penalties.
Is the finance clause mandatory in all real estate transactions?
No, while many residential real estate contracts include finance clauses, it is not mandatory. The need for a finance clause depends on the agreement between the buyer and the seller.
Can the terms of a finance clause be negotiated?
Yes, like many aspects of real estate transactions, the terms of a finance clause can be negotiated between the parties involved before finalizing the contract.
If a buyer secures better loan terms than those specified in the finance clause, what happens?
If a buyer secures more favorable terms (e.g., a lower interest rate, higher LTV ratio), the sale typically proceeds without issue, as such outcomes benefit the buyer.
Must a finance clause be in writing?
Yes, to be enforceable, all terms, including finance clauses, should be documented in the written sales contract or as an addendum to it.
Related Terms with Definitions
- Loan-to-Value (LTV) Ratio: A financial term used by lenders to express the ratio of a loan to the value of an asset purchased, expressed as a percentage.
- Interest Rate: The proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding.
- Discount Points: Fees paid directly to the lender at closing in exchange for a reduced interest rate.
- Origination Fees: Fees charged by a lender for processing a new loan application, used as compensation for putting the loan in place.
Online Resources
- HUD.gov - Information on federal housing programs and policies
- Mortgage Bankers Association - Resources on mortgage banking and financing
- CFPB - Consumer Financial Protection Bureau, resources on borrowing
References
- Real Estate Finance and Investments by Peter Linneman
- Principles of Real Estate Practice by Stephen Mettling, David Cusic, and Jane Somers
Suggested Books for Further Studies
- Real Estate Investment and Acquisition Workbook by Howard A. Zuckerman and George D. Clayton
- Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques by Frank J. Fabozzi
- Real Estate Finance & Investments (Real Estate Finance and Investments) by William Brueggeman and Jeffrey Fisher
Real Estate Basics: Finance Clause Fundamentals Quiz
### What is the primary function of a finance clause in a real estate transaction?
- [x] To outline specific conditions for financing that must be met by the buyer.
- [ ] To set the closing date for the sale.
- [ ] To negotiate the property price.
- [ ] To determine the buyer's earnest deposit amount.
> **Explanation:** The finance clause's primary function is to outline specific conditions related to financing that must be met for the buyer to be obligated to complete the sale.
### What can a finance clause help a buyer avoid if financing conditions are not met?
- [x] Losing their deposit or incurring penalties.
- [ ] Securing a better interest rate.
- [ ] Negotiating a lower sales price.
- [ ] Appraisal fees waiver.
> **Explanation:** The finance clause allows the buyer to withdraw from the transaction without losing their deposit or incurring penalties if the specified financing conditions are not met.
### Is it possible to negotiate the terms of the finance clause?
- [x] Yes, the terms can be negotiated.
- [ ] No, the terms are set by the bank.
- [ ] Only sellers can negotiate it.
- [ ] It varies by state law.
> **Explanation:** The finance clause terms can be negotiated between the buyer and the seller before finalizing the contract.
### What does the term "loan-to-value (LTV) ratio" refer to?
- [ ] The veteran's own percentage in mortgage.
- [x] The ratio of the loan to the appraised property's value.
- [ ] Mortgage insurances percentage.
- [ ] Federal rate of provided loans.
> **Explanation:** The loan-to-value (LTV) ratio refers to the ratio of the loan amount to the appraised value of the property, expressed as a percentage.
### If a better loan term is secured than stated in the offer contract, what must happen next?
- [ ] Buyer must re-open negotiations.
- [ ] Proper changes should be made in laws.
- [x] The sale proceeds with the beneficial terms.
- [ ] Ignored by overall process.
> **Explanation:** If a buyer secures better loan terms than those stated in the finance clause, the sale generally proceeds, as this is beneficial for the buyer.
### What is typically outlined in a finance clause?
- [x] Conditions of financing such as minimum loan amount and maximum interest rate.
- [ ] Only the purchase price of the home.
- [x] Specifications for the home inspection.
- [ ] The seller's counter offers.
> **Explanation:** A finance clause usually includes conditions for financing, such as the minimum amount to be financed, minimum loan-to-value ratio, and maximum interest rate.
### For enforceability, where should a finance clause be documented?
- [ ] At the lender's website.
- [ ] With an annual payment plan.
- [x] In the written sales contract or addendum.
- [ ] It does not need documentation.
> **Explanation:** To be enforceable, finance clauses should be included in the written sales contract or as an addendum to the contract.
### If a finance clause includes a maximum origination fee of 2%, can this be exceeded?
- [ ] Yes, without consequences.
- [x] No, the deal may be terminated if it exceeds.
- [ ] Only upon seller's approval.
- [x] Need a lawyer's administration.
> **Explanation:** If the origination fees exceed the maximum specified in the finance clause, the deal may be terminated, and the buyer can withdraw from the transaction without penalties.
### Who benefits from a finance clause?
- [x] The buyer, by protecting them from adverse loan conditions.
- [ ] The seller, through mitigation.
- [ ] The financial institutions.
- [ ] The real estate agents involved.
> **Explanation:** The buyer benefits from a finance clause, as it protects them from adverse loan conditions and allows withdrawal from the transaction if conditions aren't met.
### What must occur for a buyer to back out under a finance clause?
- [x] Failing to meet pre-specified financial conditions.
- [ ] Unchecked interest rates update.
- [ ] Only seller's interest in withdrawal.
- [ ] Free chunk of administration.
> **Explanation:** If the financing conditions specified in the finance clause are not met, the buyer can back out of the sales contract without penalty.
