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How Does A Mortgage Contingency Work?

Victoria Araj4-minute read

November 19, 2020

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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 sale process. 

For example, what if a potential buyer signs a contract for a new home, but then they can’t secure mortgage financing? That’s when the mortgage contingency comes into play. This provision allows buyers to walk away from the sale with no penalties and a refund of their earnest money deposit.

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 mortgage contingency period must be agreed upon by the buyer and seller. It typically spans between 30 and 60 days.

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How Does A Mortgage Contingency Work?

When you’re ready to buy a property, the first step is to submit a purchase offer to the seller. If the buyer has not been preapproved for a mortgage or isn’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 the buyer is 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. Thanks to the 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.

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 dollar amount for which the buyer must be approved in a loan. This condition acts as a secondary protection for the buyer. If they are approved for a mortgage but not the amount listed in the contract, they can cancel the sale without consequences. 

Interest Rate

The mortgage contingency clause also sets the mortgage interest rate for which the buyer must be approved. This lending term is negotiated between both parties, and it’s crucial that the buyer is satisfied with the interest rate laid out in the purchase agreement. That way, if the seller requests an interest rate that is too high, the buyer can walk away to avoid committing to a rate they cannot afford.

Closing Or Origination Fees

Before signing the purchase agreement, 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.

Mortgage Contingency Date

As mentioned above, the mortgage contingency period mandates how long the buyer has to secure the appropriate loan. 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. The seller is not obligated to grant a contingency extension.

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Should You Waive A Mortgage Contingency?

Although the mortgage contingency clause is included in most real estate agreements, some buyers may choose to waive it. Buyers may consider this option if they are paying for the property in cash or 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 will 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 loan process. Both parties should be prepared to discuss lending terms during negotiations and understand the risks of waiving the clause altogether. 

Buyers should evaluate their financial situation and their ability to pay off a mortgage before diving into homeownership. To prepare for that big step, visit our Learning Center and study the ins and outs of mortgages and buying a home.

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Victoria Araj

Victoria Araj is a Section Editor for Rocket Mortgage and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.