What Is a Mortgage Contingency and How Does It Work?
Learn how the mortgage contingency works in real estate, safeguarding your home purchase and earnest money deposit.
A mortgage contingency serves as a protective clause in a real estate purchase agreement. This contractual provision allows a homebuyer to withdraw from a purchase offer without financial penalty if they are unable to secure the necessary mortgage financing. Its inclusion is designed to safeguard the buyer’s earnest money deposit. Without such a clause, a buyer whose financing falls through could risk losing this deposit, which can range from 1% to 5% of the sales price.
Understanding the Mortgage Contingency
A mortgage contingency makes the sale of a property conditional upon the buyer successfully obtaining specific financing. This clause is a common safety net for buyers, allowing them to exit the contract and recover their earnest money if they cannot secure the required loan. It provides a defined period for the buyer to finalize their mortgage. Sellers often accept this contingency as it is standard practice in real estate transactions.
Common Conditions Within the Contingency
A mortgage contingency includes precise conditions that must be satisfied for the sale to proceed. One primary condition is the buyer’s approval for a mortgage of a specified amount or a percentage of the purchase price by a set deadline. The contingency may also detail that the loan must be obtainable at or below a certain interest rate or on specific terms.
An appraisal contingency is frequently integrated within the mortgage contingency, requiring the property to appraise for at least the agreed-upon purchase price. If the appraisal comes in lower, the buyer may have the option to renegotiate the price with the seller or terminate the contract without losing their earnest money. Furthermore, the lender’s final underwriting approval is often a condition.
Process During the Contingency Period
The mortgage contingency period, commonly lasting between 30 to 60 days, begins once the purchase agreement is signed. During this time, the buyer applies for a mortgage and provides all requested documentation to the chosen lender. This includes submitting financial records and cooperating with the appraisal process for the property.
The buyer’s objective is to secure a loan commitment letter from the lender by the contingency deadline. This letter is a formal document from the lender confirming loan approval under specific terms and conditions. If the buyer obtains this commitment, they provide it to the seller, signaling that the contingency has been fulfilled and the sale can move forward. The contingency may be waived if financing is secured earlier.
Outcomes When Conditions Are Not Met
If the conditions of the mortgage contingency are not met by the specified deadline, the buyer has the right to terminate the purchase agreement. This means the contract is terminated, and the buyer can recover their earnest money deposit without penalty. For example, if the buyer cannot obtain the specified financing or if the property’s appraisal value falls short, they can walk away from the deal.
Conversely, if a buyer chooses to waive the mortgage contingency to make their offer more competitive and subsequently fails to secure financing, they risk losing their earnest money deposit. This contingency protects buyers from being contractually bound to a purchase they cannot finance.