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Subject-Free Isn’t Always Hassle-Free

DustanWoodhouseDustan Woodhouse, AMP, Dominion Lending Centres
Special to CMT

With the spring market in full swing and bidding wars playing out in some of our largest cities – now’s the perfect time to talk about subject-free offers.

With multiple offers and over-asking-price bids now common in some cities, it’s not unusual for buyers, in the heat of the home-buying experience, to contemplate a ‘subject-free offer’ – that is, an offer without conditions. But those can come with risks.

As many buyers come to discover, lenders never grant final approval until they are comfortable with the property details. It matters little that you’re a AAA client, packing a large down payment, stellar credit and strong documented income.

Even with the most creditworthy buyers, there can always be an unanticipated hitch with the property itself. That’s why you’d be hard pressed to find a professional Realtor who would write an offer without a ‘subject to inspection’ clause, and for good reason.

Similarly, few mortgage professionals would advise you to make an offer on a property without a ‘subject to financing’ clause. That’s because no broker or banker can offer 100% assurance of financing without assessing the property details. Until an appraisal is reviewed and approved, the application is not complete.

Depending on the lender, there are some properties they simply won’t lend against. Obvious examples include properties that:

  • Contain asbestos, aluminum wiring or underground oil tanks;
  • Are remediated former grow-ops or drug labs;
  • Exhibit foundation or mould problems.

But there are also less obvious ones:

  • Live-work units;
  • Row homes (attached non-strata properties);
  • Properties smaller than 450-500 square feet;
  • Properties on leased land, be it government, First Nations or otherwise.

When it comes to the appraisal process, there’s more than simply the value to consider. Valuation is a challenge in only a small minority of cases. In fact, when the value is below $750,000, many property valuations are essentially ‘auto approved’ by the lender or insurer’s computer algorithms.

A myriad of complications can occur, however, and one such example relates to the home’s remaining economic life (REL). REL is distinct from a property’s physical life. It refers to how long a house is likely to remain standing given its current state and the care it is receiving.

Few lenders will lend on a home with an REL of less than 15 years. Moreover, the maximum amortization typically cannot exceed REL minus five years, which can sometimes drive payments sky high, and often leaves clients unable to debt service.

Another problem can occur with properties located in a neighbourhood where older structures are being purchased for demolition and replaced with multimillion dollar homes. In some cases, your purchase might look to the lender like a speculative land play or potential knock-down. In such cases, the appraiser could peg the remaining economic life at just 15 years…or less.

Or maybe the property is a ramshackle house in disrepair. It might look like the bargain of the decade on paper, and perhaps the purchaser is even a contractor planning to restore its glory. The problems is, appraisals view the current remaining economic life of the home ‘as it sits’ not ‘as is planned’. Homes like this could have an REL as short as five years.

At times, buyers also run the risk of their own good qualifications hindering mortgage approval. Those with significant liquid assets and strong incomes buying a smaller, older home on a street of newly built monoliths will sometimes be seen as planning to knock the home down and build a new one.

But the land value alone should overcompensate for this, you say?

Maybe, but lenders are not in the business of writing conventional AAA mortgages on properties that will be torn down. This is considered speculative or investment/business lending, which presents greater risks. There is a reason land/construction financing carries higher rates and additional fees. A property with a habitable home is easier to liquidate upon default.

The bottom line is that lenders prefer security over risk, and you should too. The wise approach is to minimize purchase risk by either writing offers that contain both ‘subject to inspection’ and ‘subject to financing’ clauses. At a minimum, have a detailed conversation with a skilled mortgage professional well in advance of writing that unconditional offer.