What Is A Financing Contingency?
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.
Table of Contents
- The financing contingency is a contractual clause that protects the financial interests of real estate buyers. It enables them to rescind the contract without paying penalties or forfeiting their earnest money deposit if securing the mortgage for property purchase within the contingency period is not possible.
- A buyer can waive such a clause to compete with other buyers who can deposit higher earnest money.
- A mortgage contingency differs from an appraisal contingency because an appraisal contingency allows a buyer to invalidate a real estate purchase agreement if the property price does not match the value agreed upon in the agreement within a given period.
Financing Contingency Explained
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:
#1 – Home Purchase
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).
#2 – Commercial Real Estate
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.
#3 – Investment Property
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.
How To Waive?
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:
- Seeking advice from a real estate attorney or financial advisor before proceeding can facilitate decision-making. This involves reviewing the purchase contract to understand the terms of the clause and the consequences of waiving it. If the attorney or financial advisor recommends it, one may consider the waiver.
- Obtaining a solid pre-approval for a mortgage from a reputable lender offers the confidence needed to proceed with a property purchase. In such cases, buyers do not need this clause.
- By negotiating the loan contingency and waiver terms with the seller, buyers can safeguard their financial interest and agree to waive the clause.
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:
- Showing proof of securing finance to the seller, such as a commitment letter from the lender, helps concretize the plan to waive the clause.
- The next step is to sign an addendum or agreement to waive the mortgage contingency and seek the necessary approvals and documents per the contract’s requirements and timelines.
- After waiving the loan contingency, buyers must abide by all financing obligations and deadlines in the contract, including the closing process.
Financing Contingency vs Appraisal Contingency
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.
|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.
Frequently Asked Questions (FAQs)
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.
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.
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.
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 –