Rising Rates and Residential Contracts

Unless you have been living under a rock (or can’t bring yourself to look!), you don’t need anyone to tell you that, along with home prices, mortgage interest rates have been steadily rising thus far in 2022. The average monthly mortgage interest rate has risen nearly three points from one year ago. This increase, of course, is the result of the Federal Reserve aggressively raising its benchmark interest rate in an attempt to cool down the economy (and the housing market) and bring down inflation. However, the Federal Reserve has signaled a willingness to continue raising rates aggressively until inflationary pressures ease. When that will occur and where the average mortgage interest rate will land at that time is anyone’s guess, which is why it is so crucial that all parties properly plan for such uncertainty when drafting a real estate contract, as further discussed below.

Pay Attention to Language In The Contract Addressing Interest Rates

There are several sections of the FAR/Bar contract, which we often see left blank as a matter of course. One such section is Section 8(b) on line 92 of the AS-IS Contract or line 93 of the Standard Contract. Wherein it states that the Contract is contingent upon the Buyer obtaining loan approval “at an initial interest rate not to exceed ______%.” If left blank, the prevailing rate is based on the Buyer’s creditworthiness. As previously mentioned, this section is routinely left blank. Perhaps this is due to the average interest rate being so low for so long that buyers, and their agents, got used to this section not being a big concern. Whatever the reason, it is imperative that this section not be left blank and that it receives the consideration it deserves from all parties.

Interest Rates Should Also Concern Sellers 

The Contract’s provisions concerning interest rates contained in Section 8(b) should be of great concern to Buyers for apparent reasons. Namely, Buyers should want to ensure that the Contract is contingent upon obtaining a loan at an interest rate that they can afford to make the monthly payments. What may not be so obvious is why Sellers should pay equally close attention to this section, especially at this time. For example, the Buyer writes in Section 8(b) that the Contract is contingent upon loan approval at an interest rate of 4%, and the Seller does not notice said terms. If this occurred a year ago, it would likely be ignored and no problem. However, it would be virtually impossible for any Buyer to obtain a loan at 4% as it stands today. The Seller, in this example, might waste several weeks with their home off the market only for the Buyer to cancel due to not obtaining a loan at a 4% interest rate. The Seller will need to review Section 8(b) before signing to avoid this.

Carefully Review Rate Lock Terms And Plan Accordingly

With interest rates rising at a rate we have not seen in quite some time, it is more important than ever to carefully review the terms of the rate lock agreement between the Buyer and Lender. Rate lock agreements often contain per diem fees every day that the loan does not close beyond the agreed-upon Closing Date. These fees can be pretty costly. Even worse, if the rate lock agreement expires and paying the per diem fees is not an option, Buyers may lock in at the new rate, which could have risen significantly from the initial rate lock. To avoid this, Buyers need to make sure the chosen Closing Date is realistic in terms of the Lender having sufficient time to clear the loan to close and pay close attention to the terms of the rate lock agreement, as discussed above.

Different times call for different approaches, and we are indeed in other times than we were a year ago. Do not ignore the interest rate for all parties to a real estate contract to avoid the costly mistakes discussed above! If you have any questions on this or any other real estate topic, please do not hesitate to reach out to your trusted local real estate attorney.

Sincerely,

Andrew Conaboy, Esq.  aconaboy@berlinpatten.com
Andrew focuses his practice on residential and commercial real property transactions.

 

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