Bank denying loan after "subject-to" appraisal: What to do?

Question

I'm buying a two-unit investment property directly from the seller (no Realtors involved). The purchase price is $110k.

I am trying to get a conventional loan through a large national bank. Everything went smoothly until the appraisal came back. The house appraised at $140k "subject to" repairs to the exterior (which needs repainting and replacement of some of the wood siding). The appraisal didn't assess the home's value in its "as is" current state.

The appraisal report estimated that the cost of repairs would total about $15k. I got an estimate from a contractor for performing the same repair work before even making an offer on the house, and his estimate was right around that same number.

The bank is telling me that they won't approve the loan unless the repairs are made before closing. There is no way the seller is going to do the repairs himself, and I am not going to pay to have them done before I own the house, of course (although that is what the loan officer ludicrously suggested I do -- I think she is new at her job).

I have two questions. First, is the bank being unusual or unreasonable in denying the loan without the repairs being made before closing? Here's why I think the bank's position is unreasonable: Both units of the house are currently occupied, with tenants paying fair-market rates (according to the appraisal). The house certainly needs a coat of paint and siding replacement in some places, but it is by no means structurally unsound or uninhabitable. I am buying the house for $110k with 25% down and the house appraised for $140k -- so the LTV ratio remains well above the 80:20 threshhold even with the cost of repairs factored in. I have excellent (800+) credit, have about $500k in assets (of which ~$200k are totally liquid), make about $150k a year and have zero debts (I own my personal home free and clear) -- so it's not like I'm just squeaking by when it comes to buying this house. Frankly, I think the bank is being silly in wanting to deny me -- a very good applicant -- a loan for a relatively small amount of money (relative to my income and assets) for a house that appraised for well more than the purchase price. But maybe I am failing to see things fairly from the bank's perspective.

The second question is: How do I move forward? As I see it, I have three options:

1. Try to figure things out with the current lender. If I do this, any advice on how to proceed? Should I try going over the loan officer's head, for example? Or insist that they get the appraiser to re-appraise for the as-is value of the house, rather than the value subject to repairs? (Why they didn't appraise in as-is state originally, I have no idea.)
2. Try getting financing from another lender. Ideally, I'd hope to be able to use the same appraisal because I've already paid about $800 for it. But I'm not sure how hard this is to do, and I don't want to end up back in the same situation with another bank.
3. Buy the house in cash, which I can comfortably afford to do using my $200k in liquid assets. I'd just prefer not to tie up so much money in this property. Plus, if I buy in cash, then the money I have already paid for the appraisal definitely goes down the drain.

I know I could likely do a rehab or construction loan as a fourth option, but that seems like overkill for a house that needs a relatively minor amount of work, and given that I can pay for that work very comfortably using cash.

Answer 1

I'm not sure about your first two options. But given your situation, a variant of option three seems possible.

1. Buy in cash.
2. Do the repairs.
3. Have that bank give you a loan.

That way you don't have to throw away your appraisal, although it's possible that you'll need to get some kind of addendum related to the repairs.

You also don't have your liquid money tied up long term. You just need to float it for a month or two while the repairs are being done. The bank should be able to preapprove you for the loan.

Note that you might be better off without the loan. You'll have to pay interest on the loan and there's extra red tape.

I'd just prefer not to tie up so much money in this property.

I don't understand this. With a loan, you are even more tied up. Anything you do, you have to work with the bank. Sure, you have $80k more cash available with the loan, but it doesn't sound like you need it. With the loan, the bank makes the profit. If you buy in cash, you lose your interest from the cash, but you save paying the interest on the loan. In general, the interest rate on the loan will be higher than the return on the cash equivalent.

A fourth option would be to pay the $15k up front as earnest money. The seller does the repairs through your chosen contractor. You pay the remaining $12.5k for the downpayment and buy the house with the loan. This is a more complicated purchase contract though, so cash might be a better option.

You can easily evaluate the difficulty of the second option. Call a different bank and ask. If you explain the situation, they'll let you know if they can use the existing appraisal or not. Also consider asking the appraiser if there are specific banks that will accept the appraisal. That might be quicker than randomly choosing banks.

It may be that your current bank just isn't used to investment properties. Requiring the previous owner to do repairs prior to sale is very common in residential properties. It sounds like the loan officer is trying to use the rules for residential for your investment purchase. A different bank may be more inclined to work with you for your actual purchase.

Answer 2

The first red-flag here is that an appraisal was not performed on an as-is basis - and if it could not be done, you should be told why. Getting an appraisal on an after-improvement basis only makes sense if you are proposing to perform such improvements and want that factored in as a basis of the loan. It seems very bizarre to me that a mortgage lender would do this without any explanation at all.

The only way this makes sense is if the lender is only offering you a loan with specific underwriting guidelines on house quality (common with for instance VA-loans and how they require the roof be of a certain maximum age - among dozens of other requirements, and many loan products have their own standards). This should have been disclosed to you during the process, but one can certainly never assume anyone will do their job properly - or it may have only mentioned in some small print as part of pounds of paper products you may have been offered or made to sign already.

The bank criteria is "reasonable" to the extent that generally mortgage companies are allowed to set underwriting criteria about the current condition of the house. It doesn't need to be reasonable to you personally, or any of us - it's to protect lender profits by aiding their risk models. Your plans and preferences don't even factor in to their guidelines. Not all criteria are on a a sliding scale, so it doesn't necessarily matter how well you meet their other standards.

You are of course correct that paying for thousands of dollars in improvements on a house you don't own is lunacy, and the fact that this was suggested may on it's own suggest you should cut your losses now and seek out a different lender.

Given the lender being uncooperative, the only reason to stick with it seems to be the sunk cost of the appraisal you've already paid for. I'd suggest you specifically ask them why they did not perform an as-is appraisal, and listen to the answer (if you can get one). You can try to contact the appraiser directly as well with this question, and ask if you can have the appraisal strictly as-is without having a new appraisal. They might be helpful, they might not.

As for taking the appraisal with you to a new bank, you might be able to do this - or you might not. It is strictly up to each lender to set criteria for appraisals they accept, but I've certainly known of people re-using an appraisal done sufficiently recently in this way. It's a possibility that you will need to write off the $800 as an "education expense", but it's certainly worth trying to see if you can salvage it and take it with you - you'll just have to ask each potential lender, as I've heard it go both ways. It's not a crazy or super-rare request - lenders backing out based on appraisal results should be absolutely normal to anyone in the finance business.

To do this, you can just state plainly the situation. You paid for an appraisal and the previous lender fell through, and so you would like to know if they would be able to accept that and provide you with a loan without having to buy a whole new appraisal. This would also be a good time to talk about condition requirements, in that you want a loan on an as-is basic for a house that is inhabitable but needs cosmetic repair, and you plan to do this in cash on your own time after the purchase closes. Some lenders will be happy to do this at below 75%-80% LTV, and some absolutely do not want to make this type of loan because the house isn't in perfect condition and that's just what their lending criteria is right now.

Based on description alone, I don't think you really should need to go into alternate plans like buy cash and then get a home equity loan to get cash out, special rehab packages, etc. So I'd encourage you to try a more straight-forward option of a different lender, as well as trying to get a straight answer on their odd choice of appraisal order that you paid for, before trying anything more exotic or totally changing your purchase/finance plans.