What Is A Mortgage Contingency And How Does It Work?
When your offer to buy a home is accepted and you negotiate a purchase price with the seller, it’s a legally binding agreement. It also requires an earnest money deposit. This shows the seller that you’re serious about buying their home.
However, if you need to pull out of the deal for a variety of reasons, you’re at risk of losing your earnest money and facing legal repercussions. To protect yourself, it usually makes sense to include contingencies or legal ways to get out of the deal in your purchase offer. While there are many different types of contingencies, one of the most common is the mortgage contingency.
Understanding what a mortgage contingency is and when it makes sense to waive it can help you purchase a home in a competitive market.
What Is A Mortgage Contingency?
A mortgage contingency, or financing contingency, is a clause in the real estate purchase agreement. Specifically, a financing contingency clause states that if you can’t get the financing, as in a mortgage approval, the contract is null and void. This means the earnest money deposit will be returned to the buyer and the seller will relist the home.
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Why Is A Mortgage Contingency Important?
When you make an offer on a house, you’ll need to include some assurance to the seller that you can pay for the property. This usually takes the form of a mortgage preapproval letter with your offer to show that a lender has verified your financial information.
But a preapproval and approval are not the same thing, and there’s always a chance that a problem will arise that delays or cancels your closing. For example, your lender may not be able to approve for a mortgage if:
- You lose your job
- Your financial situation changes
- You need to take out a new debt like a car loan
- There are problems with your loan documentation
- The home’s appraised value comes back too low
For this reason, buyers have traditionally included a mortgage contingency or financing contingency in their purchase agreement. It protects them if they’re unable to get a mortgage.
How Does A Mortgage Contingency Clause Work?
Once you have an offer accepted, you can negotiate a purchase agreement. It’s at this point in the home buying process that you can put in a mortgage contingency. This is basically a clause that says you can back out of the deal if your financing falls through.
It’s important to note that sellers like certainty as much as you do. 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. Both parties are restored to their initial position – the seller is free to relist, and the buyer gets their earnest money returned so they can walk away without any further obligation.
What To Include In A Mortgage Contingency
To make a mortgage contingency legitimate and to protect both the buyer and seller, there are some specifics that should be included in your purchase agreement.
Loan Type
Is it a conventional loan or are you getting financing backed by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA)? Some sellers will care about the loan type because appraisal and inspection requirements can be different.
Loan Amount
This may or may not be for the purchase price associated with the offer itself, depending on how much savings you might have to bring to the table and still close the deal.
Max Interest Rate
Sellers need to know the highest interest rate at which you still feel comfortable affording the mortgage on a monthly basis. If you get approved, but the interest rate is higher, your contingency is activated and you can get out of the deal.
Origination Fee Limit
To secure a desired interest rate, you might need to pay some amount in mortgage points at closing. One mortgage point is equal to 1% of the loan amount. The purchase agreement should specify the maximum number of points that you’re willing to purchase.
If you’d have to pay more than the maximum number of points to reach your desired interest rate, you’d be able to walk away from the purchase.
Date To Remove Contingency
To protect themselves, a seller may require that any mortgage contingency clause have a time limit, sometimes referred to as a kick-out clause. Essentially, if the buyer can’t secure a mortgage within a certain amount of time the seller has the right to put their home back on the market.
Other Mortgage Contingencies To Know
There are lots of different contingencies that can also be included in a purchase agreement. Some of the most common types that you should consider besides a financing contingency include the following:
- Home inspection contingency: A home inspection contingency allows you to back out of the sale if the findings reveal problems with the home during the home inspection process. For the contingency to be enforceable, there are usually specific conditions named in the contract in which you can walk away and get your deposit back.
- Home appraisal contingency: A home appraisal is an evaluation of the value of the property based on similar properties in the area. Lenders usually require it in case of a mortgage default. The appraisal contingency lets you walk away if the home is appraised for less than expected and the seller is unwilling to negotiate.
- Title search contingency: A title search confirms that there are no competing claims on the home before you buy. If the title company finds that there are any liens, judgments or previously unknown easements on the property, a title search contingency allows you to exit the deal.
- Home sale contingency: If you are selling your home and buying a new one, this makes your offer contingent on the sale of your current home. Otherwise you risk having to make two mortgage payments if you can’t sell your current home.
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When Should You Waive The Mortgage Contingency?
The choice to waive a mortgage contingency will depend on your real estate market conditions and your own financial situation. If you find yourself in one of the following scenarios, you could consider waiving the financing contingency:
You Want To Make Your Offer Competitive
While the housing market has cooled, a lack of available housing stock means that it’s likely to be a seller’s market for some time.
As a result, in many real estate markets around the country, sellers are often fielding multiple offers above asking price from potential buyers. To help sweeten their offer, home buyers may waive the financing contingency.
You Want To Use Delayed Financing
In real estate, everyone loves a cash offer. If you want to stay competitive and can raise the necessary funds, you might consider making an all-cash offer instead of applying for a traditional mortgage.
After you complete the purchase, you can take advantage of delayed financing. With delayed financing, you can pay in cash upfront and then do a cash-out refinance within 6 months after purchasing the home. That way, all your money isn’t tied up in your house.
This may also work to your advantage if interest rates are exceptionally high and you believe that you’ll be able to refinance for a lower interest rate in the near future.
The Bottom Line: Know When No Mortgage Contingency Is Needed
Before agreeing to waive any contingency, take an honest look at your finances. If you feel that you’re at risk of not being able to qualify for a mortgage due to credit, financial or employment issues, you may not want to waive the contingency, just in case.
To be more certain that you’ll get approved, using a lender with a robust review process can help. That’s why our Verified Approval includes a thorough review of your finances before issuing an approval Letter.
