Is My Type of Loan an Advantage or Disadvantage in a Purchase Offer?
How Sellers Rank Types of Financing in an Offer
Question: Is My Type of Loan an Advantage or Disadvantage in a Purchase Offer?
A reader asks: "I am in the enviable position of being able to pay cash or get a loan to buy a home. I want to buy an investment property, but you know how this market is. Multiple offers galore. Lots of buyers fighting over homes. I want my offer to be the best one, and I know the type of offer it is plays a huge role. So am I better off making an offer for cash or with a loan? And if it's a loan, what kind of loan is best? Where is my edge? What makes one purchase offer better than another when ranked against each other by type of loan?"
Answer: You are wise to consider how your offer may be perceived by the seller, because the type of mortgage loan or financing terms may greatly affect that perception. Throw into that mix a seller's market, and you're also likely to be competing against multiple offers from various buyers. Your offer will be even more closely scrutinized and judged.
Buyers would be astonished if they knew how unfairly some purchase offers are ranked. While we have Fair Housing laws that prohibit discrimination based on protective classes, other types of discrimination are not restricted. Not to mention, most sellers and their listing agents don't make a practice of telling buyers why their offer was rejected. They just reject it. They don't have to explain why.
However, it is common practice to judge a purchase offer by the type of financing the buyer chooses to use. Purchase offers are often ranked in the following manner.
The best type of offer is listed first, with the least attractive offer ranked in last place:
- Cash. This means cash on hand. It does not mean a home that is presently in escrow, as that would be a contingent sale and not a cash transaction. It also does not mean a refinance on another property that will produce cash at a later date. A cash offer is typically accompanied by proof of funds. That's because the seller won't take a buyer's word that the buyer is good for the cash. It's the equivalent of asking the buyer to produce a suitcase packed with 100 dollar bills.
Because cash is so highly rated, sometimes cash buyers are able to negotiate a discount. But don't count on that benefit in a multiple-offer situation or in a short sale. Remember, all offers, except owner financing, result in cash to the seller at the end. The main benefit to a cash offer is no appraisal requirement.
Cash offers over list price are highly desirable for homes with equity because there is no appraisal. Cash offers over list price are not desirable for a short sale, however, because if the buyer walks, the bank's expectation has already been established. It might be difficult to duplicate.
- Conventional loan. The FICO score requirements for a conventional loan are higher than those for an FHA loan. You can still get a conventional loan if your FICO score mirrors the minimum required for FHA but you will pay a higher interest rate.
Preferred rates are offered to those borrowers who put down 20% or more in cash, resulting in an 80% loan-to-value ratio or less. The lower the ratio, the lower the risk to the lender. Also, if the appraisal comes in lower, often the lender will let a borrower pay the difference in cash if the loan-to-value is less than 80%.
Another advantage to conventional loans is lender funding requirements are less stringent. The lender is much less likely to demand repairs. This fact alone makes a conventional buyer appear much more attractive than an FHA buyer. However, bear in mind, newer homes generally do not require repairs.
- FHA Loan. Many first-time home buyers opt for an FHA loan because the initial cash down payment is typically less than the amount required for a conventional loan. In addition, the FICO score requirement, per lender overlays, is much more lenient. The minimum down payment for an FHA loan is 3.5% of the purchase price.
FHA repair guidelines are not as strict as some sellers and agents believe. But older homes tend to need more repairs. Peeling paint is a huge FHA issue if the home was built prior to 1978. The home can have a concrete floor without carpeting, but it better not to have peeling paint. FHA loans are sometimes held up from closing due to funding conditions.
A pest report and clearance may or may not be required by the FHA appraiser.
- VA Loan. Veterans get the short end of the stick when it comes to loan hierarchy. Yet, VA borrowers are probably a better credit risk than an FHA buyer because the requirements to buy without a down payment are more stringent. A borrower retains the option to put a down payment on the home or buy without a down payment. Most VA borrowers choose leverage.
The downside to a VA loan is pest reports are required. When a pest work is required, the lender will want a completion certificate. If the transaction is a short sale, typically banks will not authorize payment for pest work. Short sale homes are sold As Is.
Unfortunately, due to the hierarchy and misconceptions, VA buyers often fall to the bottom of the pile of offers, while they might be the most qualified. Agents who handle a lot of short sales tend to prefer VA buyers because they know these buyers will get turned down elsewhere, which makes them a committed candidate for a short sale.
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.