Mortgage contingency: How does it work?
Quick insights
- A mortgage contingency is a clause in a home purchase contract that allows a homebuyer to back out without penalty if they can’t secure financing by a specified deadline.
- It protects the prospective homebuyer’s earnest money deposit if their loan application is denied or falls through.
- The contingency includes a timeline and loan terms that the homebuyer is required to meet, and it needs to be satisfied or formally removed before closing.
A mortgage contingency may be able to save buyers some money and protect them from unwanted stress. For this reason, you may want to review the definition of mortgage contingency, how it works, and what it includes.
What is a mortgage contingency and how does it work?
A mortgage contingency is a clause in a real estate purchase agreement that makes the final sale dependent on the homebuyer’s home loan approval. It’s like a financial safety net.
When you make an offer on a home, you’re suggesting, “I plan to purchase this home, as long as my lender approves my mortgage.” If the lender doesn’t, the contingency generally lets you walk away without losing your earnest money deposit.
Even if you get preapproved, final loan approval still depends on factors like the home appraisal, underwriting review and verification of your financial information.
How does a mortgage contingency work?
After your offer is accepted by the seller, the purchase agreement will outline any contingencies (including a mortgage contingency) and a specific time frame (usually 30 to 60 days) for you to secure financing. During this time, you formally apply for the home loan, submit required documents and go through underwriting.
Buying a home may require additional financing and applying for a loan. However, a homebuyer could sign a purchase contract but later find the lender does not approve them for a mortgage. That's when a mortgage contingency comes in. It protects a buyer in case they are not able to qualify for a loan.
How long does a mortgage contingency last?
The exact length of a mortgage contingency mostly depends on the signed purchase agreement and should be approved by both parties. Typically, you might see a mortgage contingency be anywhere between one and two months, which could potentially give the buyer enough time to secure the desired loan. In certain cases, it is possible to extend the deadline if the buyer is not able to secure the needed financing in time. However, it is up to the seller to determine that.
What goes into a mortgage contingency?
A mortgage contingency provides the ability to cancel a contract if financing falls through. The clause also outlines specific loan terms and deadlines that both parties agree to follow. This sets clear expectations for the financing required and the time frame to secure it. Some common details of a mortgage (or loan) contingency include:
- Loan type: Among the types of loans that could be listed are FHA loans, conventional loans or VA loans. This aspect is important to mention, considering the down payment, the loan amount and the home inspection requirements, among others, may depend on it. What's more, the buyer may not want to go with a conventional loan if they believe they are able to qualify for an FHA loan or VA loan.
- Loan amount: This is another important aspect of a mortgage contingency that may protect a buyer in case they can get approved for a mortgage but for an amount lower than needed for the specific house in question.
- Mortgage contingency deadline: As discussed earlier, the mortgage contingency deadline helps to establish a certain timeframe and prevent sellers from waiting indefinitely for a buyer to obtain financing. It might also include information on whether an extension is possible and what the process is for it.
- Maximum interest rate: A mortgage contingency also protects the prospective homebuyer by letting them choose an interest rate they can afford and are comfortable with. If it's higher than expected and stated in the clause, they may be able to pull out of the deal without consequences.
- Closing costs and origination fees: An origination fee is a percentage of the total loan amount charged by the lender to cover the processing and funding costs. Similarly, buyers can specify their maximum acceptable closing costs and origination fees in the contingency.
Can you waive a mortgage contingency?
Yes, a homebuyer can choose to waive a mortgage contingency, but there’s a potential risk. When you waive this clause, you agree to the purchase whether or not a lender approves financing. If that falls through, and you’ve waived the contingency, there may be consequences like losing your earnest money deposit.
In competitive real estate markets, homebuyers may waive the mortgage contingency to make their offer more attractive. Other situations where waiving might make sense include:
- When a homebuyer is paying for the home entirely in cash and doesn’t need financing.
- When a homebuyer has strong cash reserves and feels confident they can secure a home loan.
- When multiple offers are on the table and the homebuyer wants to strengthen their position.
In summary
A mortgage contingency is a safety measure in the purchase agreement. The clause generally lets a buyer out of the deal if mortgage financing isn’t approved in time. This is meant to protect homebuyers from walking away without losing earnest money or facing another penalty.
Mortgage contingency FAQs
1. What other types of real estate contingencies are there?
Both the buyer and seller can add contingencies to the agreement that can apply to a variety of different things. Some of the more common examples of real estate contingencies are insurance, appraisal, home sale and title.
2. What is contingency removal?
Contingency removal, also called contingency release, is a termination of the contingency clause. There are two main ways to remove the contingency, depending on the signed contract and the state’s laws. A buyer might have to sign a dedicated document to express that they agree to release the contingency. In other cases, it may expire automatically after a given amount of time. If you have questions about contingency removal, you may want to consult an expert for more information.
3. Can a mortgage contingency date be past the closing date?
The closing date is the date when all financial and payment matters are settled and the ownership of the property transfers to a buyer. So, technically, a mortgage contingency should not carry past the closing date. Also, you may want to know that in certain cases, the buyer may be able to ask for a readjustment of the closing deadline if needed.
