How Does A Mortgage Contingency Work?
Victoria Araj4-minute read
December 27, 2021
Let’s face it: The home buying process carries a lot of risks. Luckily, several types of contingencies can be built into real estate contracts to protect home buyers and sellers from unexpected changes during the sales process.
Some commonly known examples include inspection and appraisal contingencies. But what if a potential buyer signs a contract for a new home and then finds that they can’t secure mortgage financing? That’s when a financing contingency comes into play. A financing contingency – most often referred to in real estate as a mortgage contingency or a loan contingency – is a clause that allows buyers to cancel the contract of the home purchase with no penalties, and a refund of their earnest money deposit if they’re unable to secure a mortgage.
Read on to learn how adding a mortgage contingency clause to a home sale agreement benefits both home buyers and sellers.
What Is A Mortgage Contingency (Or Loan Contingency)?
A mortgage contingency is a clause in real estate transactions that gives home buyers a timeframe to secure a mortgage loan for a home. If the loan cannot be secured, the buyer can walk away without legal repercussions and have their earnest money deposit returned.
The loan contingency period is typically contracted to last between 30 and 60 days, and must be agreed upon by the buyer and seller in a purchase contract. The buyer is usually expected to secure financing and gain approval for a mortgage before closing on the house can begin.
How Does A Mortgage Contingency Work?
When a buyer is ready to buy a property, the first step is to submit a purchase offer to the seller. If they haven’t been preapproved for a mortgage or aren't sure whether they’ll qualify for the appropriate loan, they can add a mortgage contingency to the offer. Once both parties sign the purchase agreement, the buyer will submit an earnest money deposit and the seller will take the property off the market.
At that point, the buyer has the length of the mortgage contingency period to obtain financing from a lender. Once approved for the mortgage, they provide the seller with a mortgage commitment letter from their lender, and the next steps of the home closing process are set into motion.
If the buyer doesn’t qualify for the loan or fails to secure financing in time, they can terminate the contract. 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.
What Goes Into A Mortgage Contingency Clause?
The home buyer and seller must agree upon the conditions outlined in the mortgage contingency. It should include details about the following lending terms.
Mortgage Contingency Deadline
As mentioned above, the mortgage contingency period mandates how long the buyer has to secure the appropriate loan, and the deadline is typically set for sometime between 30 and 60 days. Both parties must agree to the timeframe.
In some situations, buyers and sellers may opt to include a mortgage contingency extension date in the purchase agreement. This lending term includes provisions for stretching the mortgage contingency period in case the buyer is unable to obtain the appropriate loan before the deadline. However, the seller is not obligated to grant a contingency extension, and can walk away from the sale if the contingency expires.
Type Of Mortgage
Most mortgage contingency clauses specify the type of mortgage the buyer will need to secure. After reviewing loan options, both parties must settle on the kind of mortgage the buyer will need to move forward with during the closing process.
Amount Of Money Needed
One of the most important terms of the mortgage contingency clause is the specific loan amount the buyer must be approved for. This condition acts as a secondary protection for the buyer. If they’re approved for a mortgage but not the amount listed in the contract, they can cancel the sale without consequences.
Closing Or Origination Fees
Before signing the purchase agreement, it’s important to establish what closing costs and fees the buyer will be obligated to pay to secure the loan. The mortgage lender typically charges origination fees, which include the cost of processing, underwriting and funding the loan. It’s helpful for the buyer to factor these additional fees into their home buying budget.
Can You, And Should You, Waive A Mortgage Contingency?
Although the mortgage contingency clause is included in most real estate agreements, some buyers can and may choose to waive it depending on their circumstances. Buyers may consider this option if they’re paying for the property in cash, or, with great caution, if they’ve been preapproved for the necessary loan. In a competitive market, a seller who is weighing multiple offers may ask buyers to waive the mortgage contingency in order to close the sale quickly.
Forgoing the mortgage contingency clause can be risky. If the buyer’s mortgage application falls through after waiving the protective clause, they’ll lose their earnest money deposit and be vulnerable to additional fees and potential lawsuits.
The Bottom Line
The mortgage contingency clause is a commonly used safety net to protect home buyers and sellers from unexpected changes during the home buying process. Both parties should be prepared to discuss lending terms during negotiations and understand the risks of waiving the clause altogether.
Getting ready to make an offer? Learn more about making contingent offers to keep yourself protected throughout the rest of the home buying process.
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