If you, as the buyer, are refused mortgage financing after your purchase offer is accepted, you’ll be forced to breach the sale contract and will likely lose your earnest money deposit. Loan contingencies protect buyers, making purchase contracts contingent on the buyer securing mortgage approval.
In a real estate transaction, a contingency is a legal provision that makes finalizing a property sale conditional on the terms of a designated contingency clause. Contingencies are listed in the purchase agreement — a legally binding contract between buyer and seller that lays out a timeline and expectation framework for the property sale.
In order to execute the final deed transfer, the buyer and seller are contractually obliged to meet any contingent requirements. We’ve listed the five most common contingencies listed in property purchase agreements:
- Inspection contingency.
- Appraisal contingency.
- Title contingency.
- Home sale contingency.
- Loan contingency.
We’ll be focusing on loan contingencies in this guide — more specifically, what buyers need to know about loan contingencies to successfully and safely navigate a property purchase.
What is a Loan Contingency?
Loan contingencies are a type of contingency used by buyers who plan to purchase a home on a mortgage. A standard loan contingency declares that the buyer is not contractually bound to the property sale if they are unable to secure mortgage financing by a specified date. If the loan contingency is invoked, it provides the buyer with a contractual avenue to back out of the sale or apply to a different financing institution. Loan contingencies are usually included if the buyer is seeking financing for one of the following loan types:
- Conventional loans.
- FHA loans.
- VA loans.
- Credit union loans.
- Private loans.
Including a loan contingency in the purchase agreement is not just beneficial to buyers. For sellers, a loan contingency gives buyers a way to exit the sale if they cannot qualify for a mortgage. This ensures that sellers aren’t wasting their time and energy on fruitless purchase offers.
What You Need to Know About Loan Contingencies
Keep Your Down Payment Intact
Without a loan contingency, buyers can find themselves in breach of contract if their lender delays or denies financing approval. If a sale contract is breached, the seller may receive some or all of your earnest money deposit.
Protect Against Rejection of a Pre-approved Mortgage
Before buyers begin house hunting, it’s common practice to approach a lender for loan pre-qualification or pre-approval. Mortgage pre-qualification provides buyers with a general estimate of how much they can afford to spend on a property purchase. Mortgage pre-approval is a more involved process and requires the lender to conduct a preliminary assessment of your credit and income for a specific loan amount.
Remember, if your financial circumstances have changed by the time you make an offer on a property, loan underwriters will flag the pre-qualified or pre-approved loan application for further review. For example, if a buyer is refused financing after recently taking on additional debt or suffering a loss of income, a loan contingency will allow them to exit the sale and walk away with their full earnest money deposit.
If the buyer or seller fails to meet lender-set conditions, such as additional repairs or special inspections, buyer financing will be withdrawn. To protect yourself against such an event, consider including a lender conditions provision within your loan contingency.
Passive Contingency Removal
If you’ve opted for passive contingency removal in the purchase offer, your contingency provisions will expire when the specified deadline is passed. For instance, a passive contingency removal condition may require the buyer to update the seller on financing approval no less than 20 days before the scheduled expiration date. Buyers that cannot arrange financing approval before this deadline can no longer exit the sale contract without penalty.
Active Contingency Removal
Buyers that elect for active contingency removal have more robust protection against financing delays or denial. An active contingency requires the buyer, not the seller, to set the removal requirements for the loan contingency. While this option requires more paperwork from both buyer and seller, it is a safer way to secure your earnest money deposit.
Contingencies in Market Conditions
If you are vying for a home in a hot seller’s market, you may have to adjust your loan contingency specifications to compete with other buyers. Waiving the loan contingency altogether is an option for particularly eager buyers. However, making an offer without a loan contingency can leave your deposit vulnerable in the event of an unexpected underwriting delay or denial.
Still Unsure? Reach Out to a Local Real Estate Agent!
If you’re still confused about structuring your purchase agreement and contingencies, it might be time to work with an experienced buyer’s agent. A good agent will help buyers navigate the intricacies of the property purchase process, from financing a mortgage to negotiating any contingencies on the final sale. By purchasing your home through a Clever Partner Agent, buyers can also benefit from exclusive, on-demand house showings and a $1,000 closing costs rebate.