Cause and Effect: The Home Inspection and Mortgage Relationship


 Cori Lamont  |    March 07, 2012
EktronWREM-House4.jpg

Two of the most common contingencies in a residential real estate transaction are financing and home inspection, and often one has a direct effect on the other. This article will focus on a few select situations that are a direct result of the relationship between the financing and home inspection contingencies.

What Happens When the Lender Suggests an Improper Resolution to a Discovered Defect?

Let’s look at the following example. An offer includes a home inspection contingency, and the home inspector’s report notes an issue with the basement walls; there is a structural soundness problem that will cost approximately $15,000 to $18,000 to fix. There are a number of resolutions that may be used. One possible resolution, the seller and buyer agree in an amendment to the offer that the buyer will receive a $5,500 cashier’s check from the seller at closing, accept the building as-is, and pay the balance for the repairs. On occasion, however, the lender may not agree with the parties’ resolution, and the lender may provide a resolution. 

For instance, one lender resolution, requiring that the repairs be made before the loan will be funded. Sometimes however, the lender’s suggested resolution may raise a red flag for the licensees and the parties. For example, when the lender suggests that the buyer and seller handle the repairs separately outside of the transaction without a trace of evidence to be discovered by the underwriter is mostly likely fraud. It would appear that such suggestion to address the basement issue outside of the transaction paper trail that a likely frauid is being committed on the underwriter/secondary market.

Licensees cannot participate in the act of fraud under Wis. Admin. Code § REEB 24.085, “False portrayal of interest, prohibited. No licensee shall draft or use any document which the licensee knows falsely portrays an interest in real estate.”

In addition, the licensee may also have the duty to disclose any side deals between the parties under Wis. Admin. Code § REEB 24.07 (4): “Disclosure of Side Agreements. A licensee, when engaging in real estate practice, who becomes aware of the fact that a party to the transaction has not disclosed that party’s entire agreement regarding the transaction to that party’s secured lender, shall disclose this fact, in writing and in a timely manner, to the party’s secured lender.”

If the licensee warns the parties and the lender about continuing forward with this apparent fraud, and the parties continue without heeding the licensee’s warning, the licensee should cease all participation. When a fraud is being perpetuated, the Wisconsin Department of Financial Institutions should be notified. For more information, including the complaint process, visit www.wdfi.org.

Why Does the Lender Care About the Condition of the Property?

Although the lender clearly has a vested interest in the condition of the property, the lender’s greater interest is in the appraisal and the appraised value of the property. The home inspection is to help the purchaser understand the condition of the property by hiring an expert to help them identify concerns relating to the property’s condition. To understand more the roles of the home inspector review Michael Von Gunten’s Article “Rules and Regulations Governing the Home Inspection Industry in Wisconsin” on page 18.

The appraisal, on the other hand, is to help lenders understand the condition of the property as it relates to the property’s value in relationship to the amount of money being loaned to the purchaser. In a traditional mortgage transaction, the property is the collateral for the loan; meaning if the borrower defaults on the mortgage, the lender may force the sale of the property for repayment of the debt. Therefore the lender needs confirmation from the appraiser that the value of the collateral is equal to or exceeds the loan amount. While the property condition is obviously not the only factor an appraiser takes into account, it does play a role in the appraisal process.

Is the Home Inspection Necessary in a Transaction with a FHA and VA Loan?

Another element to highlight in the home inspection and lender relationship is the role the condition of the property plays in specific types of loans, such as Federal Housing Administration (FHA) and Veterans Administration (VA) loans.

FHA loans require a home appraisal that is similar to a home inspection. The FHA appraisal does not guarantee the condition of the home and therefore it is imperative that the buyer does not rely on the FHA appraisal in place of the Wisconsin home inspection and should still include a home inspection contingency so that the buyer has an independent third party providing an unbiased opinion about the condition of the home.

In an FHA loan, it’s the responsibility of the FHA appraiser to confirm that the property meets FHA standards. The appraiser will note property condition defects on the property and suggest repairs or changes on the FHA appraisal report. Often these defects must be repaired as a condition of the FHA loan. FHA appraisers are not experts as to roofs, basements and structural issues.
Buyers that are receiving, for instance, an FHA loan should understand that just because the FHA appraiser did not highlight any specific condition issues with the property, it does not mean that the property is defect-free. If the buyer does not include a home inspection contingency, the buyer will not be afforded the rights provided by the contingency. Licensees should make sure the buyers understand the importance of having a home inspection on every property they are purchasing, including those funded by FHA and VA loans.

Rehab and Repairs

There is hope, however, for purchasers looking to buy a home that requires repairs. The Department of Housing and Urban Development (HUD) offers the 203(k) program. HUD proclaims that the 203(k) program is an FHA-insured loan specifically designed for homebuyers planning on repairing and occupying “handyman-specials and fixer-uppers.” The 203(k) program allows borrowers to purchase or refinance a property and include the cost of repairs and improvements in the loan. 

Below are some highlights of the program from portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/203k/sfh203kc:

In addition to the down payment requirement of approximately 3.5 percent of the property acquisition and repair costs, the 203(k) loan includes the following steps:

  • A potential homebuyer locates a fixer-upper and executes a sales contract after doing a feasibility analysis of the property with his or her real estate professional. The contract should state that the buyer is seeking a 203(k) loan and that the contract is contingent on loan approval based on additional required repairs by the FHA or the lender.
  • The homebuyer then selects an FHA-approved 203(k) lender and arranges for a detailed proposal showing the scope of work to be done, including a detailed cost estimate on each repair or improvement of the project.
  • The appraisal is performed to determine the value of the property after renovation.
  • If the borrower passes the lender’s creditworthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs and the allowable closing costs. The amount of the loan will also include a contingency reserve of 10 to 20 percent of the total remodeling costs and is used to cover any extra work not included in the original proposal.
  • At closing, the seller of the property is paid off and the remaining funds are put in an escrow account to pay for the repairs and improvements during the rehabilitation period.
  • The mortgage payments and remodeling begin after the loan closes. The borrower can decide to have up to six mortgage payments (PITI) put into the cost of rehabilitation if the property is not going to be occupied during construction, but it cannot exceed the length of time it is estimated to complete the rehab.
  • Escrowed funds are released to the homeowner during construction through a series of draw requests for work that is completed. To ensure completion of the job, 10 percent of each draw is held back; this money is paid after the homeowner informs the lender that the work has been completed and after the lender determines there are no additional liens on the property.

What is the Role of the Real Estate Licensee?

Lastly, we wrap up the discussion with the timeless scenario often presented to the WRA Legal Hotline attorneys: a defect discovered during the home inspection and the deal has fallen apart. If the seller does not disclose this defect to the next buyer, must the listing agent disclose?

If a licensee knows or is aware of information suggesting the possibility of a material adverse fact, the answer is yes. Wis. Admin. Code § REEB 24.07 (3) states that the licensee will be practicing competently if he or she makes timely written disclosure if the information suggesting the material adverse fact to all parties to the transaction, recommends the parties obtain expert assistance to inspect or investigate for the possible material adverse fact, and, if directed by the parties, draft appropriate inspection or investigation contingencies. The duty to disclose has priority over any duty to the client.

For further discussion, see the following Legal Updates: the August 2004 Legal Update, “Effective Home Inspections,” at www.wra.org/LU0408; the October 1999 Legal Update, “Home Inspections,” at www.wra.org/LU9910; and the National Association of REALTORS® field guide for Home Inspections may be viewed at www.realtor.org/libweb.nsf/pages/fg311.

Cori Lamont is Director of Brokerage Regulation and Licensing for the WRA

Copyright 1998 - 2017 Wisconsin REALTORS® Association. All rights reserved.

Privacy Policy   |   Terms of Use   |   Accessibility   |   Real Estate Continuing Education