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What is a Mortgage Contingency Clause and How Does It Work?

Last updated 03/26/2024 by

Jamela Adam
A loan contingency clause can be an important part of your home buying process, as it protects you financially and legally in the event that your mortgage falls through. By having a contingency clause in place, you can avoid costly legal fees and headaches down the road. If you’re thinking about buying a home, be sure to speak with your real estate agent about including a mortgage contingency in your purchase contract. This way, you’ll have peace of mind during the purchasing process of your dream home.
Buying a home is one of the most significant financial decisions you will ever make. To ensure that you’re protected financially and legally, it’s important to understand what a mortgage contingency is and how it works. In real estate transactions, a loan or mortgage contingency clause in the contract allows you to back out of the purchase if you are unable to obtain financing by a certain date. This guarantees your protection from being forced into an agreement that will be difficult or even impossible for you to afford.

What is a mortgage contingency?

A mortgage contingency is most commonly seen in a purchase offer where there are conditions such as financing before the sale will go through. To put it simply, it means that if a buyer cannot find a lender or other financial institution willing to provide them with a loan, they have the option of canceling their offer on the property. This gives each party time to reevaluate their decision and search for new opportunities without being locked into a bad deal.

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How does a mortgage contingency work?

It’s always a good idea to have a contingency plan when it comes to buying a house. This is especially true if you’re not sure whether or not you’ll be able to secure financing for a property during the home buying process. In this case, having a contingency plan in place gives you a way to back out of the deal and can save you a lot of money in the long run.
There are several real estatecontingencies in a home purchasecontract that allows you to back out of the deal with your earnest money, such as home sale contingency clauses, home inspection clauses, and mortgage contingency clauses.
When shopping for a home, you’re likely buying with the intention of getting a mortgage from a bank or a lender. If this doesn’t happen, you can lose your earnest money deposit to the seller. A mortgage contingency clause allows you to get your financing in order before committing to buying the home. This typically means that you can cancel the purchase agreement within a designated time frame if you are unable to obtain financing.

What does a mortgage contingency clause consist of?

Mortgage contingency deadline

Mortgage contingency deadlines are important for both buyers and sellers of a house. The buyer needs to be aware of the deadline to know when they need to have their mortgage approved. While the seller needs to know the deadline so they can plan for what will happen if the sale falls through. In most cases, the buyer has 30 to 60 days to secure the appropriate loan. However, there are times when sellers may be willing to extend this period for buyers, though they are not obliged to.

The type of loan the buyer will need

The majority of loan contingency clauses also specify the types of mortgage loans the buyer will need to secure. Here are some examples:
  • Graduated-payment mortgage: A type of mortgage where initial payments are low and slowly increase over time.
  • Balloon mortgage: A loan with a one-time payment due at the end of the mortgage term.
  • Adjustable-rate mortgage: A home loan with an interest rate that can change periodically.
  • Closed mortgage: A restrictive type of mortgage that cannot be refinanced, prepaid, or renegotiated without paying penalties to the lender.
  • Participation mortgage: A loan in which two or more people have fractional equitable interests.

Closing or origination fees

Closing costs may include fees related to underwriting and origination of a mortgage loan, commissions for real estate agents involved, and other loan closing fees. It’s important that these costs are established and agreed upon before signing the purchase agreement.

Appraisal contingencies vs. mortgage contingencies

Appraisal and loan contingencies are both clauses in a contract that protect one party or the other from unforeseen circumstances, but they do so in different ways.
A loan contingency gives the prospective buyer an opportunity to secure a loan within a certain time frame. Even if the financing falls through, the buyer can walk away from the contract without legal and financial repercussions. An appraisal contingency, on the other hand, provides sellers with protection against appraisals. In short, if the property doesn’t appraise for what you agreed upon, then you can back out of the deal without penalty.

Reasons why financing might fall through

If you are buying a house with an FHA loan, VA loan, or any other type of government-backed loan, your lender must first approve it. This means that if you are denied the loan, then you might not be able to buy that home at all. That’s why many people insist on including a loan contingency clause in home purchase contracts just in case financing falls through unexpectedly. Here are some examples of why this might happen:
  • You or your spouse might take a pay cut and no longer meet the lender’s criteria.
  • Lenders could modify their guidelines due to government regulations.
  • Your credit score could go down due to a missed payment or increased debt-to-income ratio.
  • The lender might refuse to provide financing due to the low appraised value of the property you’re planning to buy.
  • Missing paperwork or information.

Should you waive your mortgage contingency?

Should you waive your mortgage contingencies? You might want to give it some thought. Because waiving the mortgage contingency means that you won’t be able to back out of the contract without penalties if an issue arises.
On the other hand, waiving a loan contingency could give you an advantage when you’re buying a home. In a seller’s market, removing a mortgage contingency shows the seller how interested you are in purchasing the property. However, by doing so, you risk losing your deposit and not being able to back out of a bad deal.

How long does a mortgage contingency last?

A mortgage contingency typically lasts 30-60 days. If you cannot secure financing for the property within this time frame, then the deal with the seller will be canceled and your earnest money will not be refunded.
In some cases, buyers and sellers may choose to include a mortgage contingency extension date in the purchase agreement. This allows flexibility in the mortgage contingency period in case the buyer is unable to secure a loan before the deadline. However, the seller is not required to grant a contingency extension with the current buyer and can choose to opt for another offer.

Why some may choose to waive a mortgage contingency?

Some home buyers may feel that mortgage contingencies are unnecessary. Especially if they are already pre-approved for a loan or they have other sources of financing. For example, paying in cash. Other buyers waive the contingency clause to improve the chances a seller will accept their offer. This is particularly important in hot markets with low inventory and a multitude of cash buyers.
However, the decision to waive the mortgage contingency is not one you should take lightly. If you don’t get approved for the mortgage, you may lose your deposit and earnest money.

Should I have a mortgage contingency in the purchase agreement?

In general, it is recommended that you opt for a loan contingency clause whenever possible, as it provides a measure of protection in case something goes wrong. For example, if the property appraises less than the purchase value, the mortgage lender might reduce the amount of financing they’re willing to extend or increase the interest rate. This means that you will end up paying a lot more for the property than you planned.
However, when the housing market is strong and there are multiple competing home offers, removing contingencies can work in your favor. Because sellers will find your offer more attractive compared to contingent contracts.
Before making a decision on whether to include a mortgage contingency, you should definitely consult with your real estate agent and weigh the pros and cons. Also, consider whether or not you’re comfortable with losing your earnest money deposit.

Should a seller accept a mortgage contingency?

A mortgage contingency clause in a purchase offer allows the potential buyer to back out of the sale if they are unable to obtain a mortgage within the contingency period. This can be a risky proposition for the seller, as they are tying up their home and may lose out on other potential buyers.
However, if the seller is confident that the buyer will be able to obtain a mortgage, they may be more likely to accept an offer with a mortgage contingency clause. This gives the buyer peace of mind knowing that they will be able to buy the home, and also allows them a way to back out of the sale without losing their earnest money deposit.

Can you still make an offer on a house that is contingent?

Yes, you can still make an offer on a house that is contingent. In fact, unless the house is listed as ‘sold’, you can make an offer at any stage of the home buying process. However, if you want the property seller to back out of their offer with the current purchase contingent buyer, be prepared to place a highly attractive offer.
An attractive offer can mean paying a higher earnest money deposit upfront, or not including mortgage contingency clauses in your purchase agreement.

What happens after a loan contingency is removed?

When a mortgage contingency is removed, you are legally obligated to go through with the purchase of the property. This means that you are responsible for coming up with the financing necessary to complete the purchase. If you somehow fail to secure financing and choose to cancel the contract, you’ll lose your earnest money deposit and even be subject to additional fees and potential lawsuits.

Key takeaways

  • Without loan contingencies, you can put yourself at risk of losing your earnest money and even face legal repercussions.
  • Mortgage contingencies usually last around 30 to 60 days, with a possible extension from the seller.
  • In a seller’s market (competitive housing market), a non-contingent offer is usually more appealing to the seller.
  • You can make an offer at any stage of the home buying process, even when other buyers have already made a contingent offer.
  • For sellers, a loan contingency helps ensure that the buyers are serious about securing the mortgage loan in a timely manner.

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