You’ve found the perfect home, but like most people, you can’t pay in cash. You’ll be taking out a mortgage to buy the house. However, when you apply, you need to build in time for getting in documentation and having an appraisal done. A mortgage contingency clause in a purchase agreement gives you the time to line up financing while moving forward with an offer.
We’ll explain what a mortgage contingency is, how it works, how to decide when to use one and what you can do to meet the conditions of the contingency.
The Mortgage Contingency Clause, Explained
A mortgage contingency is a clause in the real estate purchase agreement. Buyers use this clause to agree to purchase only if they secure proper financing first.
The purpose of the mortgage contingency is to protect the buyer. In the event that they experience a loan denial for any reason after an offer has been accepted, they don’t lose their earnest money deposit by including the contingency.
An earnest money deposit, also called a good faith deposit, is paid by the buyer to the seller in exchange for taking their property off the market and goes toward your down payment if the loan closes. If the loan doesn’t close, you can lose your deposit. Because it’s usually a percentage of the loan amount, the loss can be significant without a contingency.
How Mortgage Contingencies Work
if you’re looking to include a mortgage contingency with your offer, you should understand how the process works. Let’s get into this.
Once you have an offer accepted, you can negotiate a purchase agreement. It’s at this point in the homebuying process that you can put in a mortgage contingency. This is basically a clause that says you can back out of the deal if your financing falls through.
It’s important to note that sellers like certainty as much as you do. In order to get them to accept an offer with a mortgage contingency, you need to give them a reasonable expectation that the transaction will close. We recommend all of our clients get a Verified Approval with income and asset documentation prior to formally looking for a home.
Mortgage contingencies are part of a group of stipulations you can negotiate into contingent offers. Contingent offers feature one or more conditions under which you can get your deposit back. Here are the more common contingency conditions:
- Inspection: While it’s not required, it’s a good idea for all homebuyers to get a home inspection before moving forward so that they know what they’re getting into. An inspection is a thorough going-over of the structure and all the major systems within a home. By having a contingency, you can back out of the deal for major items defined in your purchase agreement, like an HVAC system that needs replacement or the need for a new roof.
- Appraisal: In order to buy a home with a mortgage, you’ll need to have an appraisal done. An appraisal is an evaluation of the property you’re buying based on sales of similar properties in the area to assign a value. The value is key because the mortgage company can’t give you more than the home is worth as the house serves as collateral for the loan. This prevents you from losing your deposit if you can’t come to terms on a deal after an appraisal comes in lower than expected.
- Title: You could put a contingency in place that there has to be a clean title. This means that after the title company goes through does its checks, no one else has an ownership claim to the property.
- Home sale: A home sale contingency is intended to prevent you from having to take on two mortgage payments at once by making your offer contingent on the sale of your current home. In negotiating this, a seller may want you to list your home by a certain date.
To make a mortgage contingency legitimate, there are some specifics that should be included in the negotiations. The seller will want to know these so they have an idea of what they are agreeing to.
- Loan type: Is it a conventional loan or are you getting financing backed by the FHA or VA? Some sellers will care about the loan type because appraisal and inspection requirements can be different.
- Loan amount: This may or may not be for the amount of your preapproval associated with the offer itself, depending on how much savings you might have to bring to the table and still close the deal.
- Max interest rate: Sellers need to know the highest interest rate at which you still feel comfortable affording the mortgage on a monthly basis. If you get approved, but the interest rate is higher, your contingency is triggered and you can get out of the deal.
- Origination fee limit: To secure an interest rate, you generally have to pay some amount in mortgage points. One mortgage point is equal to 1% of the loan amount. However, if you have to pay more than a certain number mortgage points to get your max interest rate, you may be able to back out of the deal.
Mortgage Contingency Date
Everything is negotiable, but to be on the safe side in a purchase, it’s a good idea to ask for up to 60 days in which to secure financing and close. The caveat here is that you’re working with a real estate agent, they’ll know the common timeline in your area and how long it takes to get things like the appraisal, inspection and title work done.
In this window, several things will need to be completed so you can close:
- Home inspection (assuming you have one)
- Final documentation checks (employment, income and assets)
- Title work
Should You Use A Mortgage Contingency?
In general, unless you have a ton of cash on hand and you don’t want any chance of losing the house, it’s a good idea to put in a mortgage contingency. In a highly competitive market where you might be competing with cash offers, you might consider waiving the contingency. In this case, you can take a look at doing delayed financing.
With delayed financing, you can pay in cash up front and do an immediate cash-out refinance so that all your money isn’t tied up in your house. Obviously, this only works if you have a ton of cash available or assets you can easily liquidate for currency. Many people end up having to use a mortgage contingency regardless of their desire to keep the process simple.
Meet Your Contingency Conditions
One of the biggest keys to meeting the terms of your mortgage contingency and getting to the closing table is to control what you can control.
With that in mind, while it’s good to get a Prequalified Approval so you have an idea of how much you can afford, we recommend all of our clients take the next step and get a Verified Approval. Income and asset documentation is shared upfront and speeds the process.
If you’re ready to move forward with buying a home, you can get started by applying online.