October 18th, 2011 by Alice Alvey, CMB Realtors and sellers constantly struggle with trying to identify if a pre-approval letter is worth the paper it is written on. The costs and delays associated with accepting an offer from an unqualified or marginal buyer can be significant. Even a good loan originator can have a problem when buyers change their financial condition during processing or investors change underwriting requirements before closing. But these changes are legitimate extenuating circumstances that can cause a genuine denial of a previously approved loan. With a legitimate denial, the buyer is entitled to a refund the earnest money deposit. However, in many cases a change in circumstance does not constitute a denial and the lender must be careful to stay within the requirements of the Equal Credit Opportunity Act (ECOA). Assuming there is a fairly standard purchase agreement, the buyers are only entitled to a refund when the buyer is denied based on the terms and conditions requested. In this article I’ll review a few scenarios to test your knowledge of when a buyer is truly entitled to a refund of the earnest money deposit due to a denial of the loan application. Let’s start with a basic scenario: The buyer applies for a conventional loan of $80,000 to purchase a home with a price of $100,000. The buyer has stable income, acceptable qualifying ratios, acceptable credit and over $35,000 in the bank for funds to close. The loan originator provides a pre-approval letter subject to an appraisal. However, two weeks later the appraiser determines a value of $95,000. Is the borrower approved or denied? If you’ve been in the business a long time you have a thousand questions that all start with the words ‘that depends’ or ‘what if’. Don’t over think this. Straight up the borrower has enough funds to close, has acceptable credit and qualifies. However, the maximum loan amount without private mortgage insurance will change due to the low appraisal. This is a counter offer to the buyer and the original approval terms are not available. Therefore, there is a legitimate denial based on insufficient collateral. Now that the easy appraisal problem scenario is out of the way, let’s just look at borrower issues. In this scenario you have a fully qualified borrower purchasing 123 Main St. and the recent paystub becomes outdated during processing. Just before closing, the buyer finds their dream home on North Ave. at a steal and wants to back out of the 123 Main St. contract. In this scenario the borrower still qualifies and there is not a legitimate reason to issue a denial notice just because the paystub is outdated. The buyer will have to forfeit the EMD on the Main St. contract if they want to put in an offer on the dream home. The same problem occurs when a buyer floats the interest rate at application and then locks later at the best rate in town on a 30 year fixed but doesn’t get to closing on time. If rates increase and the buyer still qualifies, there may not be a legitimate reason under ECOA to issue a denial. Each case has to be assessed to identify the causes for the rate expiration but in a lot of cases the lender and the borrower need to come to an agreement because ‘I didn’t get the rate I wanted’ is not a reason for denial. Lenders have an obligation to stay very factual about the circumstances surrounding the loan applications and not fall for the emotional plea from the buyer to try to get a refund of the EMD.