Understanding Finance Clauses in Real Estate Agreements

When purchasing a property, having a solid financial plan is crucial. A Finance Clause or Finance Addendum included in the Agreement of Sale specifies the conditions under which the buyer is liable to complete the purchase. Understanding these conditions can make the difference between a smooth transaction and a problematic one.

What Is a Finance Clause?

A finance clause sets the specific conditions that must be fulfilled for the buyer to secure adequate financing for the purchase. If these conditions are unmet, the buyer may not be obligated to proceed with the transaction, safeguarding their financial interests.

Key Components of a Finance Clause

Finance clauses typically include, but aren’t limited to, the following conditions:

• Minimum Amount to Be Financed: Sets the minimum amount that must be borrowed for the property purchase. Ensures that the buyer can secure enough funding to make the transaction viable.
• Minimum Loan-to-Value (LTV) Ratio: Indicates the minimum allowable loan-to-value ratio, typically expressed as a percentage. A lower LTV ratio means the buyer can only borrow a smaller portion of the property’s value.
• Maximum Interest Rate: Specifies the highest possible interest rate acceptable in the loan agreement, protecting the buyer from unaffordable repayment terms.
• Maximum Discount Points: Limits the number of discount points (pre-paid interest to secure a lower rate) the buyer can acceptably pay at closing.
• Maximum Origination Fees: Caps the allowable loan origination fees, which are fees charged by lenders for processing the loan.

Real-World Example

Let’s frame a real-world scenario to make this clear. Jane is buying her first home and includes a finance clause with the following terms:

• A minimum of $200,000 must be financed through a mortgage.
• The loan-to-value (LTV) ratio should be at least 80%.
• The interest rate should not exceed 4.5%.
• No more than 2 discount points should be required.
• Origination fees must not surpass $3,000.

If Jane cannot secure a mortgage fulfilling these criteria, she is not legally bound to close the sale, safeguarding her from unfavorable financial terms.

Likely Benefits of Finance Clauses

• Financial Protection: These clauses protect buyers from entering contracts that could lead to financial strain or default.
• Negotiation Power: Buyers can use finance clauses to negotiate better terms, potentially improving their financial situation in both short and long terms.
• Clear Conditions: Clearly stated conditions help reduce misunderstandings between buyers, sellers, and lenders.

Frequently Asked Questions

What happens if the financial criteria specified in the finance clause aren’t met?

If the specified financial conditions aren’t met, the buyer usually isn’t obligated to finalize the purchase. This provides a way to exit the agreement without financial penalty.

Can finance clauses vary from one transaction to another?

Yes, finance clauses can be customized to meet the particular needs and financial conditions of the buyer and the property transaction.

Are finance clauses for the benefit of the buyer or the seller?

Typically, finance clauses primarily benefit the buyer by ensuring they can secure reasonable financing. However, clear terms also help sellers understand the buyer’s financial capabilities, contributing to a smoother transaction overall.

Related Terms: mortgage contingency, loan approval process, real estate contract, property financing, mortgage lenders