Contingencies are an essential part of any home purchase contract, protecting buyers from financial risk if things don’t go according to plan. The financing contingency, also known as a mortgage contingency, is especially important for buyers who need a loan to purchase a home.
It gives you the right to cancel the sale and keep your earnest money if your financing falls through before closing. Without this clause, you could lose your deposit – or worse, be legally required to close on the home without financing.
Whether it’s your first time buying a home in Seattle, WA or you’re looking to invest in a condo in Austin, TX, understanding how a financing contingency works can help you navigate the process and avoid costly mistakes. In this Redfin article, we’ll break down exactly what a financing contingency is, why it’s important, and how it can protect you throughout the homebuying process.
What is a financing contingency?
A financing contingency, sometimes called a mortgage contingency, is a clause in a home purchase agreement that protects buyers who need a mortgage to complete the purchase. It gives the buyer the right to cancel the deal and keep their earnest money if the mortgage application is denied or they are unable to secure financing under the terms outlined in your contract.
Even if you’re pre-approved for a mortgage, unexpected issues can prevent loan approval, such as a low appraisal, changes to your credit, or a change in employment. The financing contingency gives you a legal “out” if one of these issues prevents you from closing.
How does the financing contingency work?
Once the seller has accepted the buyer’s offer and both parties have signed the purchase agreement, the financing contingency period begins. It typically lasts 30 to 60 days, though the exact timeline is set by the terms agreed to in the contract.
Here’s a step-by-step look at how it typically works:
1. Apply for a mortgage
Even if you have pre-approval, you must submit a formal loan application to your lender.
2. Submit financial documents
This usually includes tax returns, pay stubs, bank statements, and credit information. The lender uses these to verify your ability to repay the loan.
3. Lender review and appraisal
The lender reviews the application, conducts underwriting, and orders an appraisal to ensure the home’s value is equal to or more than the mortgage loan amount. The home appraisal typically occurs within 48 hours of the lender’s request.
4. Loan decision and next steps
Once underwriting is complete, the lender either approves or denies the mortgage.
If the loan is approved: The lender issues a clear-to-close mortgage commitment letter that the buyer will usually share with the seller. This letter confirms the loan is approved and ready to fund, and the sale moves toward closing.
If the loan is denied or issues arise: If financing problems occur, like a low appraisal, credit changes, or employment changes, buyers have several options, provided the contingency is still active and all contract terms are met:
- Request an extension: If more time is required to secure financing, the buyer can ask the seller for an extension. The seller may accept or reject the extension.
- Seek alternative financing: The buyer may pursue different lenders or loan types.
- Cancel the contract: The buyer may choose to walk away without losing their earnest money.
Example scenario of the financing contingency
You’re buying a $450,000 home with a 45-day financing contingency. During this period, your lender denies your mortgage because of a recent vehicle purchase that substantially increased your debt-to-income ratio. Because the contingency is active and all contract conditions were met, you can cancel the deal and retain your earnest money deposit – protecting you from a major financial loss.
What is included in a financing contingency?
The financing contingency is only effective if it remains active and all terms in the contract are met. Waiving the contingency, missing deadlines, or failing to act in good faith can eliminate these protections.
A financing contingency can vary from contract to contract, but most include several key components that define the buyer’s rights and obligations:
Timeframe: Usually 30 to 60 days to secure financing. If the buyer can’t get a loan by the deadline and hasn’t requested an extension, they risk losing their earnest money.
Loan type: Specifies whether the buyer is using a conventional, FHA, VA, or jumbo loan. This matters because each loan type has different requirements and approval timelines.
Loan amount: The buyer must be approved for a loan amount that covers the purchase price. If the loan comes in short (often due to a low appraisal), they may need to renegotiate or walk away.
Interest rate cap: Some contingencies include a maximum acceptable interest rate. If mortgage interest rates spike above that number, the buyer can cancel the deal.
Earnest money protection: This is the core of the clause – it ensures the buyer can walk away and keep their earnest money deposit if financing falls through.
Closing costs: Occasionally, this section outlines who pays which closing costs, though that’s often negotiated separately.
Why the financing contingency matters
Including a financing contingency is important because it protects buyers from being legally obligated to complete a home purchase if they can’t secure a mortgage. Purchase agreements are legally binding contracts, so without this clause, failing to close could expose you to legal or financial penalties.
According to a recent survey of Redfin agents, 27.8% of canceled home-purchase agreements were due to buyer financing falling through, and 14.9% were due to a change in the buyer’s financial situation. The financing contingency is a crucial protection for buyers, especially those using a loan to purchase a home.
Real-world example
Sarah waived her financing contingency to win a bidding war. But when the appraisal came in $40,000 below the purchase price, her lender reduced the loan amount. Sarah didn’t have enough cash to cover the difference and ended up losing her $10,000 deposit when she couldn’t close on the home sale.
Situations where waiving the financing contingency may be riskier
Even in a competitive market, there are situations where waiving this protection could put you at serious financial risk. You may want to keep the financing contingency in place if:
- You’re a first-time homebuyer. If you haven’t gone through the mortgage process before, you may not be aware of potential delays or surprises that can derail financing.
- You have a low down payment. Smaller down payments may trigger stricter lender requirements or private mortgage insurance (PMI), increasing the chance of financing issues.
- Your income is variable or recently changed. If you’re self-employed, just changed jobs, or have inconsistent income, lenders may take longer to approve your loan—or deny it altogether.
- You’re buying a unique or hard-to-appraise property. Unusual homes can cause appraisal challenges that impact loan approval.
- You’re using a government-backed loan. FHA or VA loans often have longer processing times and stricter property standards, which could create unexpected delays.
In these cases, keeping the financing contingency gives you critical protection if something doesn’t go as planned.
Situations where waiving the financing contingency may make sense
In hot housing markets, buyers sometimes waive contingencies to strengthen their offer, but that comes with risk. Here are a few scenarios where waiving your financing contingency might make sense:
- You’re paying in cash. If you’re not relying on a mortgage to finance the home, the financing contingency becomes irrelevant. Cash buyers have a significant advantage in a competitive market because they eliminate the risk of financing falling through.
- You have a strong pre-approval. If your lender has already given you a solid pre-approval, you may feel confident that your loan will be finalized. Strong pre-approvals often come with assurances that your financing is nearly certain, reducing the risk of backing out.
- You’re making a large down payment. A substantial down payment can reduce the chances of financing complications. Lenders may see buyers with larger down payments as lower risk, making the loan process smoother and more likely to close without issues.
- You’re confident in your financial situation. If you’re in a stable job, have a high credit score, and have no significant changes expected to your financial situation, you might be more comfortable waiving the contingency, as the chances of your financing falling through are low.
Even if one or more of these factors apply to you, waiving a financing contingency still carries risks. If your loan falls through, you could lose your earnest money or even be legally obligated to follow through with the purchase. For this reason, it’s essential to evaluate your situation and the market conditions carefully before deciding to waive this common contingency.
How to protect yourself if you waive the financing contingency
If you decide to waive this clause, here are a few ways to lower your risk:
- Work with a reliable lender: Partnering with a lender known for efficiently closing loans can help avoid issues later in the process.
- Increase the down payment: A larger down payment can improve the chances of loan approval and lower the risk of financing falling through.
- Have a backup plan: In the event that financing is not secured, having alternative options such as a bridge loan or private lending in place can help protect the buyer.
FAQs: Financing contingency in real estate
How long does a financing contingency last?
A financing contingency typically lasts 30 to 60 days, giving the buyer time to secure a mortgage approval. If the buyer is pre-approved, the process may move faster, possibly shortening the contingency period. However, if more time is needed or unexpected issues arise, the buyer can request an extension, but this depends on the seller’s approval. If financing isn’t secured by the end of the contingency period, the buyer can cancel the deal and walk away with their earnest money, as long as the terms of the contingency are met.
What happens if the financing contingency period expires without securing a loan?
If the buyer is unable to secure financing by the end of the contingency period and does not have an extension in place, they can walk away from the deal without losing their earnest money, as long as the financing contingency terms are met. However, the buyer must notify the seller that they are backing out due to financing issues. After the contingency expires, the buyer may no longer have the option to cancel for financing reasons.
Can a buyer renegotiate the terms of the loan during the financing contingency period?
Yes, during the financing contingency period, if the buyer faces issues with the loan, such as a lower-than-expected appraisal or a change in interest rates, they may try to renegotiate the terms with the seller. In some cases, they may ask the seller to lower the purchase price or offer concessions to make the loan more affordable. However, the seller is not obligated to agree to these changes.
What happens if a buyer’s financing falls through after the contingency period?
If the buyer’s financing falls through after the contingency period has ended, they are typically in breach of contract. Without the protection of a financing contingency, the buyer risks losing their earnest money and may be required to proceed with the purchase or face legal consequences. It’s essential for buyers to meet the terms of the contingency and secure financing within the set timeframe to avoid this scenario.
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