When you make a home purchase offer, including an earnest money deposit demonstrates your commitment and introduces the critical role of a mortgage or loan contingency in the buying process.
Known as the earnest money deposit, this shows that you’ve got skin in the game, and represents your good faith to buy the home. This deposit is eventually applied to the overall transaction, and appears as a credit on your final closing documents.
Your purchase offer accompanied by earnest money is usually sufficient for sellers to accept your offer, which in turn becomes a bona fide sales contract. Sellers will then take their home off the market while you prepare your financing for closing if you’re not an all-cash buyer.
But what happens if your financing falls through? Will you get your earnest money back? Is the seller left with anything? Such circumstances are outlined in an important purchase contract clause known as the mortgage contingency.
Buying a home is likely the biggest purchase you’ll ever make. With home prices continuing to rise across the country, it’s normal to feel stressed when entering the homebuying process. After all, you’re committing to pay hundreds of thousands of dollars for a property sight unseen.
That’s why it’s so important to protect yourself legally and financially at each step of the journey. One of the best ways to do that is by adding a loan contingency clause to your purchase agreement when you make an offer on a home.
What is a Loan Contingency?
A loan contingency, also known as a mortgage contingency or financing contingency, is a clause included in a home purchase agreement that gives the buyer an “out” if they are unable to secure financing before closing on the home.
With a loan contingency in place, the buyer can back out of the deal without losing their earnest money deposit if their mortgage application is denied or they are unable to obtain approval in time
Why is a Loan Contingency Important for Home Buyers?
There are a few key reasons a loan contingency provides important protection:
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You haven’t seen the full property yet. When submitting an offer, you are agreeing to purchase a home you likely haven’t fully inspected. If the inspection uncovers expensive repairs, you may no longer be able to afford the monthly mortgage payment. The loan contingency allows you to back out in this case.
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You don’t have final loan approval yet It takes weeks to get a mortgage formally approved. Even if you are pre-qualified or pre-approved, the lender still needs to verify your financial information is accurate before closing. The loan contingency protects you if you ultimately don’t qualify
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The appraisal may be lower than expected. If the home appraises for less than your offer amount, your lender may not approve the loan. The loan contingency lets you walk away if this happens.
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Interest rates could rise. Even a small increase in mortgage rates between offer and closing could alter your monthly payment. With a loan contingency, you can renegotiate terms or walk away if rates jump.
What Should Be Included in a Loan Contingency Clause?
There are several key details that go into crafting an effective loan contingency:
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Timeframe. The clause should include a deadline, typically 30-60 days, for you to secure financing.
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Loan amount. The exact mortgage amount you need to be approved for should be specified.
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Loan type. The clause should note whether you need a conventional, FHA, or VA loan.
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Interest rate. Include the max rate you are willing to accept.
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Buyer responsibilities. Outline what you agree to do to secure financing during the process.
How Does a Loan Contingency Work in a Home Purchase?
Here is the typical process when a loan contingency is in place:
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You submit an offer with a loan contingency clause included.
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The seller accepts and you provide an earnest money deposit to show you are serious.
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You apply and get conditionally approved for a mortgage loan.
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The lender provides a commitment letter approving you for financing within the terms of the contract.
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You send the commitment letter to the seller as proof you met the contingency.
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If you don’t obtain financing in time, you can terminate the contract with no penalties and receive your deposit back.
Can You Waive the Loan Contingency?
In some cases, buyers may consider waiving the loan contingency to make their offer more appealing to sellers. However, this comes with risks, including:
- Losing your earnest money if financing falls through
- Being liable for fees and penalties if you can’t close
- Having no leverage to renegotiate if the appraisal is low
Before waiving the contingency, be certain you are fully approved and can cover any appraisal gaps in cash. Or require the seller reduce the price if the appraisal is low.
Other Common Contingencies in Home Purchase Agreements
Along with the loan contingency, there are other contingencies buyers often include for protection:
Home inspection contingency – Allows you to cancel if the inspection reveals undisclosed problems
Appraisal contingency – Lets you renegotiate or cancel if home appraises for less than purchase price
Title contingency – Provides an out if there are issues found during the title search
Home sale contingency – Gives time to sell your current home before closing
Repair contingency – Requires seller to fix problems found during inspection
The Bottom Line
Purchasing a home is a huge responsibility. Protect yourself by including a well-written loan contingency clause in your offer. This simple inclusion provides important legal and financial protection at a time when so much is still unknown about the property.
With a loan contingency in place, you can proceed confidently through the home buying process knowing you have an “out” if your financing unexpectedly falls through. Work with a real estate agent experienced in writing strong offers, and you’ll be well on your way to owning your dream home.
Why a mortgage contingency is important
Mortgage contingencies are not just contractual formalities; they are essential safeguards that protect both buyers and sellers in real estate transactions. According to recent data, a significant portion of residential real estate deals include a mortgage contingency clause, underscoring its critical role in todays market. This clause is particularly vital in volatile markets or during financial downturns, where the certainty of loan approval can be less predictable. For buyers, a mortgage contingency provides a safety net, ensuring that if loan approval falls through for certain reasons, they can withdraw from the deal without losing their earnest money deposit. Sellers, on the other hand, gain the assurance that the buyer is earnest in their attempt to secure financing, safeguarding the seller from prolonged market absences due to failed transactions.
In times of economic uncertainty, the absence of a mortgage contingency can significantly impact both parties. Buyers could face the loss of substantial earnest money deposits, while sellers might experience delays in finding another buyer, potentially missing out on favorable market conditions. The inclusion of a mortgage contingency clause is a testament to the importance of protecting all parties involved in a real estate transaction, ensuring that the process is fair and equitable.
As the buyer, the mortgage contingency protects you financially in several ways.
Mortgage Contingency Offers: Protection in the event of loan denial
While you may be confident that your mortgage will go through without a hitch, there are some things beyond your control that can affect your ability to qualify. For instance, if you suddenly lose your job or if there are issues with the property’s title, appraised value, or condition, a lender may deny financing.
In these cases, the mortgage contingency may allow you to back out of the contract without any legal ramifications.
Mortgage Contingency Offers: Protection from losing your deposit
A loan contingency can also prevent you from losing your earnest money deposit, which is the deposit made to a seller that represents your commitment to buy the home. If your financing falls through for any reason within the designated time frame, your deposit will be returned to you in full.
It’s important for you and your real estate broker or agent to negotiate for this protection before you sign the purchase agreement.
In any real estate transaction, time is of the essence. If there are any circumstances that may jeopardize meeting your loan contingency, then talk to your agent or representative right away.
What is a mortgage contingency?
In real estate transactions, contingencies are a lot like the “hurdles” of the race. They are the conditions both buyers and sellers must meet before the agreement is finalized and you get the keys to your new home.
While there can be contingencies for just about anything, such as the house passing inspections, the sale price meeting the appraised value, or even the seller fixing broken light fixtures, the mortgage contingency (also called a “financing” or “loan” contingency) is important because it concerns the outcome of your earnest money and sets loan approval deadlines.
A mortgage contingency usually provides 30 to 60 days for buyers to secure loan approvals — which means that if buyers don’t obtain financing within that period, they risk losing their earnest money deposits, and sellers are legally allowed to cancel the contract.
What Is A Loan Contingency And Why Should You Care?
FAQ
How does loan contingency work?
What does contingent mean on a loan?
Should I remove my loan contingency?
What does it mean to waive a loan contingency?
What is a financing contingency?
Typically a buyer uses this clause to establish a set period of time to apply for a mortgage and/or close on the loan. Within this clause the buyer will also normally list the type of loan they intend to obtain, their down payment amount, the term of the loan and the interest rate. What is the Purpose of a Financing Contingency?
What is a mortgage contingency agreement?
A **mortgage contingency** (also known as a financing contingency or a loan contingency) is a clause in real estate transactions that allows home buyers to secure a timeframe for obtaining a mortgage loan.Here’s
What is a mortgage contingency clause?
With a mortgage contingency clause, either party can back out of the home sale agreement during the contingency period with no penalties. The seller will be free to pursue other offers, and the buyer will receive their earnest money deposit back. Take the first step toward the right mortgage.
Do you need a mortgage contingency?
Most real estate transactions come down to a buyer being able to acquire a mortgage. If a potential buyer signs a contract for a new home and then discovers they can’t secure financing, that’s when a mortgage contingency can come into play.