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What Happens When a Buyer Gets, then Loses a Mortgage Commitment

A real estate purchase is often financed with funds borrowed from a lender. The process for being approved for a loan is sometimes lengthy. As a result, in order to expedite the transaction, parties generally negotiate and enter into a contract before the mortgage commitment has been issued. Although the contract typically takes into account the possibility that the buyer will not be able to obtain financing, it does not usually address the problem of what happens if the buyer gets a mortgage commitment but then loses it. A recent New York case addresses this situation.

Real estate contracts usually have a “mortgage contingency clause” permitting a potential purchaser to cancel the contract and recover its down payment if he/she cannot obtain a mortgage commitment within a certain number of days. When the purchaser is successful in obtaining a mortgage commitment, the parties will generally expect the sale to proceed. If the buyer does not close, the seller will most likely have a breach of contract claim and take the position that the buyer has forfeited its deposit, which is the usual remedy provided for in the contract.

A recent decision of the New York Appellate Division, Second Department, in Chahalis v. Roberta Ebert Irrevocable Trust, addressed an interesting question: What happens if a buyer satisfies the obligation to obtain a mortgage commitment within the contingency period set forth in the contract, but after the expiration of that period, loses the commitment?

In Chahalis, the prospective buyer obtained a mortgage commitment, from a lender but one month later, lost his job. As a result, the mortgage commitment was revoked by the lender, rendering the buyer unable to proceed with the transaction. The seller refused to return the down payment arguing that since the contingency period had expired the buyer could not rely on that clause to get the deposit back.

The Court held that where a mortgage commitment is obtained and then lost, through no fault of the buyer, the mortgage contingency clause (including the time frame) does not apply. Instead, the court looked at whether the lender’s revocation of the commitment was a result of the buyer’s bad faith. In this case, the Court found no bad faith on the part of the purchaser and as a result, held that the seller must return the down payment.

The lesson in Chahalisfor buyers is to operate in good faith with respect to seeking financing. Sellers must now realize that the loss of a mortgage commitment, even outside of the contingency period, can result in the transaction being cancelled and the down payment returned. As a result, sellers should refrain from entering into other transactions or count on the proceeds from a sale until the same closes.

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