Financing Contingency, or loan or mortgage contingency, is a clause in real estate contracts or purchase agreements, which permits buyers to terminate the contract if they cannot secure the funds or loan required to execute the contract and purchase the property within a specified period. The clause allows buyers to get a refund on their earnest deposit without paying a penalty for contract termination.
A financing contingency shields buyers from adverse consequences from not proceeding with a real estate purchase after entering into a contract with the seller. The clause ensures protection from legal action or non-refund of earnest deposit in cases where the buyer is unable to execute the transaction. However, this clause is not favorable for sellers. Sellers often prioritize or prefer buyers who waive this condition, as they seek to close the deal at the earliest without a hitch.
A financing contingency is an important clause commonly included in real estate purchase contracts to safeguard the buyer's interest. It offers buyers a level of protection, which states they are not obligated to acquire the property if they cannot secure a mortgage. However, they must adhere to the conditions and timelines specified in the contingency clause to rightfully exercise this option. This time frame ensures the buyer has adequate time to apply for a mortgage, gain approval, and finalize the financing details before fully committing to the property purchase.
The process begins when a buyer submits an offer to purchase a property. The purchase agreement has several terms and conditions, including the financing contingency. Once the seller accepts the clause, the purchaser has a specified period (generally a few weeks) to secure a mortgage loan. During this timeframe, they approach a lender to obtain a commitment for financing. However, if the buyer fails to secure the funding within the specified period (contingency period), they can void the contract without paying any penalties. However, the buyer must inform the seller before the contingency period expires in case they are unable to obtain the funds for transaction execution. Failure to do so may result in an obligation to proceed with the purchase.
A loan contingency arrangement can empower the buyer during negotiations. If financing challenges arise, the buyer may leverage this contingency to negotiate more favorable terms, such as a reduced purchase price or necessary property repairs. Overall, it serves as a risk management tool for the property purchaser. On the flip side, it burdens the buyer with mortgage application fees and appraisal costs, even if the deal does not go through.
Such clauses delay the buying process and may lead to extended closing timelines. Also, if the buyer cannot obtain the loan, it can be frustrating for both parties. A mortgage contingency is less appealing to sellers who prioritize quick and specific deal closures.
Let us discuss a few examples to understand how this clause protects buyers from being forced to complete the purchase if they are unable to secure the financing terms specified in the contract:
Suppose Mr. B is buying a house for $100,000 from Mr. A. He deposits a token of $5000. The two parties enter into a purchase agreement with a financing contingency stating that if Mr. B cannot secure a mortgage for at least $90,000 at an interest rate not exceeding 5% pa within 3 months from the agreement date, he can withdraw the deal without penalty.
From the buyer’s perspective, the clause covers certain crucial components—the timeline, the upper limit (amount), and the interest rate (as it affects the buyer’s future expenses and financial planning).
Adam, a business owner, wishes to purchase a commercial property for a new store. He includes a financing contingency specifying he requires a loan with a maximum interest rate of 6% for the purchase to proceed and deposits $20000 with the seller as earnest money. However, due to Adam’s low credit score, banks and financial institutions can only extend finance at an interest rate of 7.5% and above. Hence, Adam decides to terminate the contract with the seller.
Per the clause mentioned in the agreement, Adam will not be penalized for the cancellation. The seller will be bound by contract to refund $20,000 deposited as earnest money by the owner. In this way, Adam could stay immune, protecting himself from losing $20,000.
An investor is interested in acquiring a complex for $1.5 million. They include a financing contingency stating the deal will be closed if the investor is able to secure a loan covering at least 80% of the purchase price within 60 days. If they cannot secure a financing commitment, they can cancel the contract per the mortgage contingency clause.
Purchasers often prefer to waive a financing contingency in real estate transactions to win bids against cash buyers (who are financially capable of depositing more than 30% of the earnest money). However, it is a decision with repercussions. Hence, one should consider it carefully.
Buyers may consider waiving a mortgage contingency in the following cases:
Under all circumstances, accurately interpreting the risks of waiving the financing contingency is crucial since it may lead to the loss of deposited earnest money, or even legal consequences may have to be borne.
To waive the contingency clause (based on the advice of an attorney), the following steps can be followed:
Financing and appraisal contingencies are critical in real estate contracts from the buyer’s perspective. They protect buyers from unforeseen complications during property purchase. The differences between these concepts have been discussed below.
| Basis | Financing Contingency | Appraisal Contingency |
|---|---|---|
| Definition | A financing contingency in real estate safeguards the buyer by permitting them to withdraw from the agreement if they cannot secure the required mortgage loan for purchasing the property. Buyers are not penalized; they get a refund of the earnest money deposit. | An appraisal contingency allows the buyer to void the contract if the property's appraised value falls below the decided purchase price. |
| Conditions in which it is exercised | The buyer does not get the required financing or the desired interest rate within a specific period. | When the property value does not reach or cross the amount mentioned in the purchase contract, a mismatch occurs. The clause can be activated in such cases. |
A no-financing contingency clause states that the buyer's obligation to close the real estate deal is not conditional or variable. It means that even if a loan or mortgage cannot be arranged, the deal will go through. This clause is seen in cases where the buyer already has a bank-approved mortgage, and both parties are secure in the knowledge that the funds will be available when needed.
How many days are allowed as a contingency period per a financing contingency clause?A mortgage contingency clause usually allows buyers a period of 30 to 60 days within which they must secure the funds to close the deal.
Should one waive financing contingency?Waiving mortgage contingency can be risky. Hence, buyers must consult their legal or real estate advisor before deciding. However, it can win them a property bid against wealthy buyers.
What happens when a financing contingency clause expires?If a buyer has not received mortgage approval, they must notify the seller before the contract expires to ensure the earnest money is not lost. If the buyer does not have mortgage approval documents when a financing contingency clause expires, they will be obligated to close the deal or withdraw but lose the earnest money.
This article has been a guide to What Is a Financing Contingency. Here, we explain its examples, compare it with appraisal contingency, and how to waive it. You may also find some useful articles here -
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