The bank controls the deal: Why liability for last minute loan rejections is hard to determine

It is one of the worst things that can happen to a prospective homebuyer. The financing for a home purchase falls through or is denied just before the sale, leaving too little time to secure alternative financing. The buyer will certainly lose the home. He or she may also lose the deposit, unless there was a financing or mortgage contingency in the contract of sale, and he will certainly incur various other costs and inconveniences.

Assuming the buyer did everything requested of him by the lender—furnished all required information truthfully, completely, accurately, and on time—who is liable for the financing falling through? Except in limited cases, no one is liable when the buyer’s financing falls through at the last moment.

Lenders may be in the business of lending, but they are not required to lend. A bank can decide not make loans generally. We saw this happen during the height of the credit crisis, when many banks essentially stopped offering mortgage loans. A bank can also refuse to lend to an individual for any lawful reason. They can change their underwriting criteria, for example, at will, making it more difficult to qualify for a loan. They can arbitrarily treat some income as less secure than other income, treating the applicant as a worse risk that another person making the same or less money but in a different way. (For example, many banks are reluctant to lend to the self-employed, even those making a good living.) In fact, lenders may decide to turn down a loan application for essentially any reason at all.

Worse, since lenders have no duty to lend in the first place, they suffer no liability for taking their time about making the decision to lend. Whether it’s one hour before or at the eleventh hour, lenders can chose any moment to decide whether to or not to provide financing, up until the loan is actually made (if it’s made). Because banks have this broad discretion, there is no liability for them denying a loan at the last moment. And since banks are not controlled by any other party, like the realtor or seller, there is no liability against those other parties. However, once the loan is made, it has to be available to the home buyer for the period reflected in the loan documents.

There are rare instances when a cause of action against a bank is appropriate. In cases of fraud or misrepresentation, for example, such as a bank employee altering a would-be-buyer’s application so as to cause the loan to be denied, the bank would be liable for damage caused by its employee’s actions. Another case for liability would be an instance of discrimination, when a person is denied a loan on the basis of race, sex, religion, age (over 40), disability, etc.

Beyond that, the power lies with the lender. This is why whenever possible; buyers should make sure they have a financing or mortgage contingency in the contract of sale. This will offer them some protection if financing were to fall through.