What Does a Loan Contingency Mean in Real Estate?

Real estate transactions often include protective clauses known as contingencies. These clauses establish conditions that must be met for the purchase agreement to proceed to closing, safeguarding both parties from unforeseen circumstances. A loan contingency is a common provision designed to protect the buyer’s financial interests during the home purchasing process.

Defining Loan Contingencies

A loan contingency, also known as a financing or mortgage contingency, is a contractual clause in a real estate purchase agreement. It makes the sale conditional upon the buyer securing the necessary financing. The purpose of this contingency is to safeguard the buyer, allowing them to withdraw from the contract without financial penalty if they cannot obtain a mortgage loan. This protects the buyer’s earnest money deposit if financing falls through. Earnest money, typically 1% to 5% of the sale price, is a good-faith deposit held in escrow, demonstrating the buyer’s commitment.

How Loan Contingencies Function in a Contract

A loan contingency operates within a defined timeframe specified in the purchase agreement, often 30 to 60 days. During this period, the buyer is obligated to diligently pursue a mortgage, including applying for a loan and providing necessary documentation. The contingency outlines specific conditions for the loan, such as the maximum interest rate or required loan amount, ensuring the buyer is not bound to unfavorable terms.

If the buyer secures a loan commitment within the agreed timeframe and conditions, the contingency is satisfied, and the transaction moves forward. If the buyer cannot obtain financing despite good faith efforts, they can terminate the contract without penalty. In this scenario, the earnest money deposit is returned to the buyer. However, if the buyer fails to meet the deadline or secure financing and does not properly invoke the contingency, they risk losing their earnest money.

Waiving or Removing Loan Contingencies

Buyers may choose to waive or remove a loan contingency, a decision with significant implications. This means the buyer agrees to proceed with the purchase regardless of whether they secure financing. A primary reason buyers waive this protection is to make their offer more attractive in a competitive real estate market, as sellers often prefer offers with fewer contingencies.

Waiving the loan contingency places the buyer’s earnest money deposit at greater risk. If financing falls through, the buyer could lose their deposit, as they would be in breach of contract without the contingency’s protection. Removing a contingency usually involves the buyer signing a written document, such as a contingency removal form, to notify the seller. Before making this decision, buyers should have a strong financial position or alternative funds to cover the purchase price.