How Mortgage Financing Contingencies Work (With Example Clauses)

This guide explains how mortgage financing contingencies work and other things a home buyer should consider when using them.

Here are the 5 most important points contained within this guide:

1. A financing contingency is a clause in a real estate purchase agreement that allows a buyer to back out of the deal if they can’t secure a mortgage.
2. It protects buyers from losing their earnest money deposit if they’re unable to obtain financing.(details).
3. The timeframe for the contingency can vary but is typically between 30 and 60 days.
4. In a hot housing market, having too many contingencies might make your offer less competitive.
5. Home buyers should understand every clause contained in their purchase agreements, because they have financial and legal consequences.

What Is a Mortgage Contingency, Exactly?

Within the context of a real estate transaction, a contingency is something that must happen in order for the deal to move forward.

The sale of the home becomes contingent on (or dependent upon) certain conditions or events taking place, and those events are known as contingencies.

These necessary conditions have to be identified within the real estate contract, also known as the purchase agreement.

There are several different types of contingencies used by home buyers. The mortgage financing contingency is one of the most common, and you’ll soon understand why.

Definition: A mortgage financing contingency is a clause in a home purchase agreement that allows the buyer to back out of the deal, without penalty, if they cannot secure a mortgage loan within a specified timeframe.

It Protects Your Earnest Money Deposit

This contingency protects the buyer by making the purchase dependent on their ability to get financing. It basically creates an exit strategy. If the buyer cannot get approved for a loan (for whatever reason) they can cancel the contract without forfeiting their earnest money.

In contrast, a home buyer who backs out of a deal without a valid reason stated in a contingency, they might risk losing their earnest money deposit. And that could be a big loss for the average home buyer.

On average, earnest money deposits typically range from 1% to 3% of the home’s purchase price. So, for a median-priced home of $360,000, the deposit might range from $3,600 to $10,800.

For an average home buyer, a lost deposit would be a major financial setback. Contract contingencies can prevent such losses from occurring.

And while we’re on the subject, don’t confuse the earnest money deposit with the down payment. They are two different things.

• The earnest money deposit is a good-faith payment from the buyer to show the seller they’re serious about buying the home. It usually gets held in an escrow account and applied to the purchase at closing.
• The down payment is a larger sum of money paid directly toward the home’s purchase price at closing, as required by the mortgage lender.

Real estate contract contingencies (like the mortgage finance contingency) are directly related to the earnest money deposit but have no bearing on the down payment.

An Example Financing Clause in a Contract

As far as the actual wording goes, financing contingencies can vary from state to state. Additionally, a home buyer can adjust the wording as needed to match their specific situation.

Most states have a standard document known as the residential real estate purchase agreement (or something similar). These documents usually have a fill-in-the-blank section that pertains to the mortgage contingency, if the home buyer chooses to include one.

Here is a sample financing contingency from a purchase agreement:

“This contract is contingent on the ability of purchaser to secure or receive a commitment for the financing described above within 45 calendar days from the date of acceptance of this contract, which commitment or approval purchaser agrees to pursue diligently. If, after making every reasonable effort, the purchaser is unable to obtain the specific financing, and notifies seller of this fact in writing within the term of this contingency, this contract shall become null and void and purchaser’s deposit shall be refunded in full.”

Here are the most important parts of this sample mortgage contingency:

• Timeframe — Here, the home buyers have given themselves 45 days to get a loan commitment from their lender. After that time, this contingency will expire.
• Notification — This contract clause also stipulates that the home buyer must notify the seller in writing if they are unable to secure financing.
• Refund — If the buyers do not get their loan, the contract becomes “null and void.” This means the buyers can back out of the deal without losing their earnest money deposit. The deposit would then be refunded.

In the above sample, the buyers gave themselves 45 days to get a loan commitment from their lender. But this is not a standard requirement. The number of days used for mortgage financing contingencies can vary, as explained below.

How It Ties Into the Home Buying Process

Let’s zoom out and look at the broader home buying process and how the mortgage contingency ties into it. While this process can vary from one buyer to the next, it usually looks something like this:

1. Making an offer: The buyer submits an offer to purchase a home, which includes the proposed price, closing data, and other terms.
2. Financing contingency: The buyer also decides to include a financing contingency, which protects the buyer in case they can’t secure a mortgage.
3. Seller’s review: The seller will either accept the offer as-is, reject it, or make a counteroffer to negotiate the price and any contingencies.
4. Purchase agreement: Once both parties come to an agreement, they’ll sign a purchase agreement outlining the terms, including the financing contingency.
5. Mortgage underwriting: Next, the lender’s underwriter will review the loan and the borrower’s financial details to determine if they qualify for the loan amount.
6. Property appraisal: The lender will also order an appraisal to confirm that the home’s current market value supports the loan amount.
7. Mortgage approval: The lender either approves the loan or issues conditions. Conditions might include additional documents or a letter of explanation.
8. Contingency removal: Once the loan is approved, the buyer can remove the financing contingency, committing to proceed with the purchase.
9. Closing the deal: If everything is in order, the sale proceeds to the closing stage, where the buyer signs final documents and funds are transferred.

With this approach, the home buyer creates an exit strategy in case they are unable to qualify for their mortgage loan. If they get turned down for some reason, they can exit the deal as specified in the financing contingency and recover their earnest money deposit.

“But I’ve Been Pre-Approved Already”

Many home buyers who use mortgage loans get pre-approved for a specific amount before the start house hunting. And this makes sense, because it allows you to tailor your search to that specific price range.

So you might be wondering: Why do I need a mortgage financing contingency if I’ve already been pre-approved by a lender? What could possibly go wrong?

While mortgage pre-approval offers some benefits, it does not guarantee that you’ll get the loan. Several problems could arise between pre-approval and the final closing.

Most borrowers who get pre-approved end up reaching the finish line and closing successfully. But not always. Here are some of the problems that could arise after the pre-approval process:

• Low appraisal: The home appraises below the purchase price and the seller won’t adjust it.
• Credit score drop: The buyer’s credit score decreases due to late payments or other issues.
• Job loss: The buyer loses their job or suffers an income reduction that affects their mortgage.
• New debt: The buyer takes on new debt, affecting their debt-to-income ratio and approval.
• Title issues: Problems with the home’s title are discovered, such as liens or other disputes.
• Documentation: The buyer fails to provide the required documentation or it contains errors.

A mortgage financing contingency can be designed to cover all of these scenarios, giving the buyer a way to exit the transaction without forfeiting earnest money.

How Many Days Should It Be Set for?

There is no official rule or law that says how long, or how many days, the mortgage contingency should remain active. It can vary from one real estate contract to the next.

Usually, it’s up to the home buyer to decide, since it relates to their mortgage loan. But the seller must agree to it as well, so the length of the contingency period will have to be acceptable to both parties.

On average, mortgage contingencies included within purchase agreements tend to range from 30 to 60 days. This gives the buyer enough time to clear the mortgage underwriting process and get a final approval.

But again, the timeline can vary. And it’s not binding until both parties agree to it in writing, with signatures on the contract.

Be Mindful of Contingencies in a Hot Market

In most cases, it makes sense for home buyers to include a financing contingency within the real estate purchase agreement or contract. It prevents them from losing the earnest money deposit due to something that’s beyond their control.

But there are some scenarios where buyers should tread carefully.

For instance, in a hot housing market where sellers tend to receive multiple competing offers, having too many contingencies could work against the buyer. In a competitive market, the seller might have several offers to choose from. And they typically select the one with the fewest conditions or requirements.

Related: The risks of waiving a contingency

Contracts (and the clauses and stipulations that go into them) are an important part of the purchase process. Buyers should carefully consider all of the components that go into the purchase agreement, and that includes any contingencies. When in doubt, ask your real estate agent or attorney for advice.

Disclaimers: This article includes generic language and details that might not apply to your specific situation. Real estate laws and requirements can vary from one state to the next. This article is meant for a general audience and does not constitute legal advice.