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Section 1 Clearance? Not just for FHA Loans Anymore…

May 2, 2008 San Carlos Real Estate No Comments

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You’re undoubtedly aware of how lending requirements have been tightened as a result of the severe housing situation. Lenders are requiring much higher credit scores, full documentation, larger down payments, NO late payments, etc… Well, these restrictions all pertain to the potential buyer, and their ability to fulfill the terms of the loan.

But the lending institutions aren’t stopping there. Many lenders are starting to take a much closer look at the homes they are being asked to fund. And why not? With foreclosures hitting record levels, they end up owning some of these homes down the road. There’s one VERY important condition that some lenders are starting to impose BEFORE they will fund the loan: Section 1 clearance.

“Section 1″ — What is it?

During the course of a home transaction, a “Wood Destroying Pests and Organisms Inspection” is normally completed by a qualified inspector. This is commonly referred to as a “Termite Report” or a “Pest Inspection.” (For the purpose of this discussion, they are the same.) In the back of the standard report, you’ll find the required fixes spelled out under either “Section 1″ or “Section 2″ columns. Here are some quick definitions:

  • “Section One:” Noted areas of active termite infestation or other wood-destroying insects or organisms like dry-rot fungus (likely caused by water intrusion.)
  • “Section Two:” These are usually areas that are highlighted because the inspector couldn’t visually inspect that area, and consequently there might be conditions that cause the inspector to believe there could be Section One issues.
  • “Section 1 Clearance:” A certification that is issued by a licensed inspector when ALL items highlighted in Section 1 have been remedied. This may include chemical treatment to exterminate pests, as well as replacing damaged wood caused by infestation and/or dry rot.

Up until recently, repairs to Section 1 issues were negotiated between the buyer and seller and didn’t have a bearing on the funding of the loan. In competitive bids, the buyer would likely shoulder the task of fixing the issues, and they were usually fixed after the close of escrow but before the buyer occupied the house (Sometimes they’re not fixed at all.) If a house has significant Section 1 issues and has been on the market for a long time, the buyer may negotiate the cost of the fixes with the seller. But the lenders were seldom involved, with the exception of FHA Loans. They have customarily required a Section 1 Clearance before they’ll fund the loan.

Now, some traditional lenders are starting to follow suit…and it’s popping up at the most inconvenient of times. I heard of an instance recently where a bank came in within a couple days of the close of escrow and required a Section 1 Clearance before they would fund the loan. Needless to say, this took the stress level of everyone involved right into the stratosphere.

What can you do to protect yourself? For both buyers and sellers, make sure your respective agents are communicating frequently with the lender or mortgage broker and asking if this is going to be a requirement. Experienced mortgage brokers know their lenders well, and will normally steer clear of situations like the one above. The good ones will already have a fall-back plan already in place for situations like this.

  • Important Tip — If the buyer asks for a Section 1 Clearance as part of their purchase offer, you’d better expect that the lender will require it before close of escrow, so plan accordingly.

With the ecomomy bumping along as it is, you’ll likely see this requirement more often — so in a home purchase negotiation, the sooner you know if it will affect you, the better off you’ll be.
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