What Is a Mortgage Contingency and How Does It Work?

When you’re buying a home, there are many moving parts that can feel out of your control. Perhaps the biggest gear that needs to turn in your favor is the mortgage loan. A common worry among homebuyers is to find the perfect house, put down a deposit with an accepted offer, and then learn that your mortgage application is denied — you lose both the house and your earnest money. This is where a mortgage contingency can save the day.

A mortgage contingency protects you in such situations, ensuring that you’re not left holding an empty bag if the financing falls through.

In this guide, we’ll explore the ins and outs of a mortgage contingency, helping you understand how it works and why it may — or may not be — part of your home-buying plan.

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What is a mortgage contingency?

A mortgage contingency is a clause in a real estate contract that makes the purchase contingent, or dependent, on the buyer securing a mortgage loan. It’s a legal provision that offers protection to you as a buyer, ensuring that if you can’t secure a mortgage within a specified timeframe, you can back out of the contract without facing legal or financial penalties.

This clause is particularly important for those who make an offer on a home before receiving final approval from a lender. Essentially, it’s a safety net. If your loan application is denied, or you can’t secure financing under the terms outlined in the contingency, you can withdraw from the deal and typically recover any earnest money deposit you’ve made.

A mortgage contingency, also known as a “financing contingency” or “loan contingency,” provides a layer of security, allowing you to confidently make offers, knowing that your financial investment is protected if the loan doesn’t come through.

How does a mortgage contingency work?

A mortgage contingency works by setting specific conditions that must be met for a real estate transaction to proceed. Here’s a brief overview of how it functions:

1. Setting the terms: When you make an offer on a home and include a mortgage contingency, you specify the terms. These typically include the amount of time you have to secure financing and the acceptable terms of the mortgage (like interest rate and loan type).

2. Securing the loan: During the specified period, you must obtain a mortgage that meets these terms. This involves applying for a loan, undergoing the lender’s approval process, and receiving a commitment letter from the lender.

3. Proceeding or withdrawing: If you secure the mortgage within the contingency period and the terms align with those specified in the clause, the sale moves forward. However, if you can’t secure financing or the terms differ significantly (like a higher interest rate), you have the option to back out of the contract.

4. Refund of deposit: If you withdraw from the contract due to an unfulfilled mortgage contingency, you’re typically entitled to a refund of your earnest money deposit, safeguarding your finances.

In essence, a mortgage contingency acts as a form of insurance for your home purchase, ensuring that you’re not legally bound to buy a home if the financing falls through.

Why the mortgage contingency matters for buyers and sellers

Understanding the nuances of a mortgage contingency is crucial for both buyers and sellers, as it directly impacts the risk, timeline, and security of the transaction.

For buyers

A mortgage contingency is the buyer’s primary protection against financial loss if financing fails.

• Financial safety net: It allows you to recover your earnest money deposit if your loan is denied, preventing the loss of thousands of dollars.
• Clarity on obligation: It defines the exact terms and timeline under which you are obligated to purchase the home, ensuring you aren’t forced into a deal with unfavorable loan terms (e.g., an unexpectedly high interest rate).
• Leverage in negotiation: While including the contingency may make your offer less appealing in a hot market, a well-defined clause gives you negotiating power if the loan process faces delays or unexpected hurdles.

For sellers

For sellers, the contingency represents a risk to the deal’s certainty and duration.

• Assessing risk: The presence and terms of a mortgage contingency help a seller gauge the likelihood of the deal closing. A buyer who is pre-approved with a short contingency period presents less risk than one with a lengthy, open-ended clause.
• Timeline management: It sets a hard deadline (the “kick-out clause” deadline) for the buyer to finalize financing, allowing the seller to plan their move, future purchase, and closure of the sale with greater confidence.
• Comparing offers: In multiple-offer situations, a seller will often favor an offer with a waived contingency or a shorter contingency period, as it speeds up the process and reduces the chances of the sale falling through. A seller needs to weigh the higher price of a contingent offer against the security of a faster, non-contingent one.

What information does a mortgage contingency clause contain?

Here’s a breakdown of the information typically included in a mortgage contingency clause:

• Type of mortgage loan: The clause must specify what type of loan you’re requesting. This might be an FHA, USDA, or conventional loan.
• Loan amount: The clause outlines the amount of money you need to borrow in order to finance the home purchase.
• Maximum interest rate: It includes the highest mortgage interest rate you, as the buyer, are willing to accept. This protects you from being locked into a loan with unexpectedly high rates.
• Closing or origination fees: The clause details any closing or origination fees you’re responsible for, providing a clear picture of the upfront costs involved in securing the loan.
• Sale of existing home: If applicable, the clause may state that, in order to qualify for financing, your current home or another property must be sold. This is common if the proceeds from the sale are needed to secure the mortgage loan.
• Deadline for removing the contingency: Often referred to as a kick-out clause, this part of the clause sets a specific date that the mortgage must be approved and the contingency removed from the offer. Both the buyer and the seller need this deadline to make plans, whether the sale goes through or not.

How long does a mortgage contingency contract last?

The duration of a mortgage contingency contract varies, but it typically lasts 30 to 60 days from the date of the signed purchase agreement. This period is negotiated between the buyer and seller and reflects the time deemed sufficient for the buyer to secure a mortgage.

The length of the contingency plays a key role for all involved: it must be long enough to allow for the mortgage approval process, yet not so long that it unduly delays the transaction for the seller. If the buyer cannot secure a mortgage within this timeframe, they can back out of the deal without losing their earnest money deposit. However, once this period expires, the contingency is no longer valid, and the buyer may risk losing their deposit if they can’t complete the purchase.

This is all part of the due diligence period. And while buyers can request an extension, the seller is under no obligation to grant any additional time.

from HomeLight Blog https://www.homelight.com/blog/buyer-mortgage-contingency/