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.
A contingency loan, also known as a mortgage contingency or financing contingency, is an important clause included in real estate purchase agreements that provides protection for homebuyers if they are unable to secure financing in time to close on the home This clause allows the buyer to back out of the deal without losing their earnest money deposit if they fail to obtain a mortgage loan within the agreed upon timeframe
What is a Contingency?
A contingency is a condition that must be met or fulfilled before a contract becomes binding. In real estate, contingencies allow buyers and sellers to cancel a purchase agreement without penalty if certain predefined events fail to occur.
Common real estate contingencies include:
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Home inspection contingency – Allows the buyer to cancel if the inspection uncovers issues with the home.
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Mortgage contingency – Allows the buyer to cancel if they fail to secure financing.
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Appraisal contingency – Allows the buyer to cancel if the appraisal value is lower than the purchase price
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Title contingency – Allows the buyer to cancel if there are defects found in the title records.
What is a Mortgage Contingency?
A mortgage contingency, also known as a financing contingency or loan contingency, allows the buyer to terminate the purchase agreement and get their earnest money deposit back if they are unable to obtain financing within a specified period, usually 30-60 days.
The contingency clause will specify:
- The type of mortgage the buyer intends to obtain
- The loan amount needed
- The maximum interest rate
- Any origination fees and closing costs
- The deadline to secure financing
This contingency protects the buyer from forfeiting their deposit if their mortgage application gets denied or they fail to secure a loan in time for closing. It provides them with an “out” if financing falls through.
How Does a Mortgage Contingency Work?
Here is the typical process when a mortgage contingency clause is included in a home purchase agreement:
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Buyer submits offer – The buyer makes an offer with a mortgage contingency clause included. This specifies the financing terms they need to obtain a loan.
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Seller accepts offer – The seller accepts the buyer’s offer and takes the home off the market.
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Buyer deposits earnest money – The buyer puts down earnest money to show they are serious about purchasing the home. This is usually 1-5% of the purchase price.
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Contingency period begins – The buyer has a set timeframe (typically 30-60 days) to secure financing per the terms outlined in the agreement.
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Buyer applies for mortgage – The buyer works with their lender to get pre-approved and have their mortgage application processed.
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Contingency deadline approaches – As the contingency period nears expiration, ideally the buyer has obtained a mortgage commitment letter from their lender. This satisfies the contingency.
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Buyer fails to obtain financing – If the buyer cannot secure a loan in time, they can terminate the contract without penalty before the deadline and get their earnest money back.
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Buyer secures financing – If the buyer gets mortgage approval in time, the deal proceeds to closing once the contingency is satisfied.
The mortgage contingency protects both the buyer and seller throughout this process. The buyer can safely make an offer knowing they won’t lose their deposit if financing falls through. The seller avoids having a buyer under contract who ultimately can’t get a loan.
Reasons for a Mortgage Contingency
There are several reasons why buyers commonly request mortgage contingencies:
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Haven’t been pre-approved yet – Buyers may not have a pre-approval letter yet when they want to make an offer, so the contingency provides time to get approved.
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Unsure if they’ll qualify – Buyers who are self-employed or have unique financial situations may be unsure if they’ll qualify until going through full underwriting.
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Avoid losing the deposit – Buyers want assurance they won’t lose their earnest money if financing gets denied.
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Protection from rising interest rates – Locking in current interest rates helps buyers avoid risk from rate hikes during the process.
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Down payment dependent on home sale – Buyers selling a home may need those proceeds for the down payment and closing costs.
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Job change – Buyers worried about changes in employment affecting their mortgage approval may want the contingency as a safeguard.
What is Included in a Mortgage Contingency?
Mortgage contingencies should clearly spell out the financing terms that the buyer needs to obtain for the purchase. Key details include:
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Deadline date – The specific date by which the buyer must secure their financing, typically 30-60 days from contract acceptance.
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Loan amount – The minimum loan amount the buyer needs to be approved for.
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Loan type – The specific mortgage product such as conventional, FHA, VA, etc.
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Interest rate – The maximum interest rate the buyer is willing to accept.
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Down payment – The minimum down payment based on the purchase price and loan type.
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Fees/costs – An outline of loan fees and closing costs the buyer will pay.
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Contingency release – Conditions for satisfying the financing contingency once approved.
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Right to terminate – Statement that buyer can terminate if financing terms aren’t met per the clause.
Can You Waive a Mortgage Contingency?
In some cases buyers may opt to waive their mortgage contingency, although this comes with risks:
Pros:
- Increases competitiveness of the offer for sellers
- Shows the buyer is fully committed to purchase
- Speeds up the closing process
Cons:
- Buyer loses earnest money if financing denied
- Buyer could be sued for breach of contract if unable to close
- Locks buyer into interest rates and loan terms
Waiving contingencies is risky for buyers but may make sense if you are paying cash or have been fully underwritten and approved. However, if your mortgage application gets denied after waiving the clause, you have no recourse to back out of the deal.
What Happens After Mortgage Contingency Period?
There are three potential outcomes once the mortgage contingency deadline passes:
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Financing secured – The buyer obtained financing approval by the deadline, so the deal proceeds. The contingency is satisfied.
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Contingency deadline missed – The buyer failed to secure financing in time. The seller can now terminate the contract, keep the earnest money, and look for another buyer.
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Contingency extension – If included in the agreement, the buyer may request a short extension of the contingency for additional time to obtain approval.
Once the mortgage contingency is removed and financing secured, the buyer and seller can proceed through the closing process without financing concerns.
The Bottom Line
Including a well-defined mortgage contingency in your home purchase agreement provides critical protection in case your mortgage application gets denied. It reduces the risks involved with putting down an earnest money deposit and making an offer on a home before securing financing. Be sure to consult your real estate agent when drafting the mortgage contingency terms to look out for your best interests as a buyer.
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.
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 Loan Contingency? – Real Estate 101
FAQ
How does contingency work?
What is an example of a mortgage contingency?
What does contingent mean on a loan?
What is loan contingency removal?
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
How do you get a loan with a mortgage contingency?
In order to get them to accept an offer with a mortgage contingency, you need to give them a reasonable expectation that the transaction will close. If there is a mortgage contingency in the purchase agreement and you aren’t approved for the loan within the time frame specified, it’s as if the sales contract never existed.
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.