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To protect yourself when buying a home, consider a mortgage contingency. It will protect your earnest money should you not be able to close on a loan.
Here’s how a mortgage contingency works.
What Is a Mortgage Contingency?
A mortgage contingency provides the buyer protection should they not be able to secure financing before the closing.
Most mortgage contingencies are good until a week before the proposed closing date. This gives buyers time to iron out the details of their financing without risking their earnest money.
A mortgage contingency can also include specific loan program details, interest rates, and fees buyers must secure.
If the lending terms change while the buyer is under contract, they can back out of the sale without losing earnest money or being forced into a loan they don’t want/can’t afford.
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How Do Mortgage Contingencies Work?
A mortgage contingency provides you with a way out of the contract if you can’t secure financing in time. It’s a level of protection for buyers who aren’t 100% certain they’ll be able to get a loan.
If you can’t secure financing by the contingency expiration date, you can back out of the contract, keeping your earnest money.
You can ask for a mortgage contingency when you make an offer on a home. Buyers ask for mortgage contingencies for several reasons, including:
- You haven’t been pre-approved for a mortgage yet (not recommended)
- You want to protect yourself should the home not pass the appraisal or have a clear title
- You’re worried about losing your mortgage pre-approval because your financial or credit situation changed
If the seller agrees, they’ll add the contingency to the purchase contract, giving you a legal way out if you can’t secure financing in time.
Mortgage Contingency Terms
- Loan Amount: The loan amount in the contingency can be the amount on your pre-approval or a different amount if you have the money you can contribute to the purchase if the appraisal comes in a little low.
- Interest Rates: You and the seller must agree on an interest rate you’ll take if offered. Pay close attention to this detail since it could leave you with financing you can’t afford and/or don’t want. Agree only to an interest rate you’re comfortable taking.
- Origination and Closing Fees: Set a limit to the origination fee and/or closing fees you’ll pay. This way, if the lender increases the cost of the loan beyond what you agreed to in your contract, you can back out of the deal. You won’t be stuck in a loan you can’t afford and/or don’t want.
- Mortgage Contingency Date: This is one of the most important details. Think about how long you need to secure clear financing. If you’ve been pre-approved, you may be able to ask for less time, but typically up to a week before closing is normal.
- Mortgage Contingency Extension: This gives you the option to extend your contingency if you need it. Since we can’t predict how long lenders will take to process a loan, this is important to pay attention to.
Mortgage Contingency Example: The Clause in Action
You find a home you love and want to put in an offer. You have a mortgage pre-approval, but it’s conditional.
The home must pass the online mortgage lender’s requirements in value and clear title. You aren’t 100% confident in your ability to secure the loan personally either, so you ask for a mortgage contingency.
You and the seller work out a 45-day contingency which puts you one week before the closing. You sign the contract and forward it to your lender.
The lender asks you for more documentation regarding a personal finance issue you had during the loan process.
They decide they don’t like the documentation you provide to clear it and increase your interest rate by 1%.
The interest rate is above the rate you agreed to in your mortgage contingency, and you’re still within your contingency date.
You back out of the contract and get your $10,000 in earnest money back, leaving the seller to sell the home to someone else.
>> More: Different Types of Contingencies
How Long Does a Mortgage Contingency Last?
A mortgage contingency often lasts between 30 – 60 days, but it varies by situation. Some sellers want a shorter contingency, so they have their home off the market for less time if the financing falls through.
Others don’t mind but will include a kick-out clause that allows them to accept a better off if it comes along.
What Happens If a Mortgage Contingency Expires?
If you have a mortgage contingency extension in your contract, you have the option to extend the mortgage contingency if it expires and you still don’t have full approval.
If you don’t have the extension option and the contingency expires, you may be on the hook to satisfy the contract, or if you back out, you could lose your earnest money.
What Does It Mean to Drop a Mortgage Contingency?
Most real estate contracts include a mortgage contingency unless you’re paying cash or you’re 100% sure of your ability to secure financing.
You can drop or waive the mortgage contingency but know that you do so at your own risk. If you can’t secure financing, you’ll lose the chance to get your earnest money back if you don’t buy the home.
Why Are Mortgage Contingencies Important?
It’s hard to secure financing on such a large transaction. With so many moving pieces to the puzzle, it’s important to have protection should your financing fall through.
Mortgage financing relies not only on your financial capabilities to afford a home but also on the home’s condition and value.
Lenders can cancel a mortgage for countless reasons, so having the chance to cancel the contract if you can’t secure financing is an important protection.
>> More: What Is a Home Appraisal?
Is It Smart to Use a Mortgage Contingency?
It’s generally smart to have a mortgage contingency. If you don’t, you put yourself at risk of losing your earnest money, which most people don’t want to risk.
If you’re in a bidding war and want to win, you may consider dropping the mortgage contingency, but I’d suggest dropping any other contingency you can and protecting yourself with the financing contingency because it can be so hard to get.
Are Mortgage Contingencies Required to Buy a Home?
No contingency is required, but many, like the mortgage contingency, are highly recommended. It’s best to protect yourself because you never know what may happen.
What if you didn’t lock in your interest rate and rates soar? If you don’t have the mortgage contingency, you’re stuck taking the higher rate and closing on the loan.
How Common Are Mortgage Contingencies?
Mortgage contingencies are one of the most common contingencies buyers use. Sellers typically expect them but often have parameters they’ll accept.
For example, they won’t take a contingency with no wiggle room in the interest rate or closing costs.
They know in real life, terms change, and if you can back out of the contract for any little reason, they may not accept it.
Bottom Line: What Is a Mortgage Contingency?
Protecting yourself with a mortgage contingency is important. It’s the only way to ensure you can back out of a contract if you can’t secure financing.
If you back out without a mortgage contingency, you risk your earnest money, which could mean losing thousands of dollars.