Whichever side you are in a real estate transaction, a mortgage contingency can benefit you, but it could also cause you inconvenience.
As a real estate investor, you will soon realize how complicated the home-buying or home-selling process can be. It also carries a lot of risks: if you are buying a house, you could encounter complications that could prevent you from proceeding with your purchase. And if you are the one selling, you will have to deal with buyers who might request a number of conditions and concessions in the contract.
Whether you are the one buying or selling the property, you need to know about the different contingencies that you can put in the sale agreement. There is no certainty in any real estate transaction. So it is important for you to protect yourself if something unexpected happens that keeps you from closing the sale.
This article will be all about mortgage contingency, which is one of the clauses that a buyer would want to include in the purchase agreement. Here, you will read about:
- What a mortgage contingency is
- How it works
- How long it lasts
- Waiving the mortgage commitment contingency clause
- Other types of contingency clauses
What Is a Mortgage Contingency?
A mortgage contingency is a clause in real estate transactions that can void the sale if certain conditions are not met. It gives home buyers a set timeframe to secure a mortgage loan for the home they wish to purchase. It also specifies when an official approval for the loan needs to be in place.
If the buyer cannot secure the loan in time, they can back out of the sale with their earnest money deposit. Buyers use this contingency to protect themselves in case they cannot qualify for financing.
Even if they get preapproval for a mortgage, that is not a guarantee for them to get full approval. This will depend on what the lender finds about the buyer or the property they wish to buy. Usually, buyers have to sign the contract of sale before they can get full approval on their mortgage.
This contingency also protects the seller. If the contingency expires and the buyer has not found a way to finance their purchase, the seller is free to back out of the sale. But they are not allowed to entertain other offers during the contingency period unless they include an escape clause.
How Does a Mortgage Contingency Work?
When the buyer finds a house that they want to buy, they submit a purchase offer to the seller. If they have not been preapproved for a loan or are not sure whether they will qualify for one, they can add the mortgage commitment contingency to the offer.
Next, the seller accepts their offer with the contingency and both parties sign the sale agreement. Then the buyer will deposit their earnest money in an escrow account until the deal is complete. The earnest money deposit is typically around 1% to 3% of the sale price, but the exact amount can depend on what is customary in the local market.
Meanwhile, the seller takes their property off the market. At this point, the buyer must obtain financing from a lender during the mortgage contingency period. If they were able to take out a loan and the deal goes through, the earnest money is applied to the buyer’s down payment and closing costs.
There are cases of the buyer asking for an extension when they have not obtained a loan by the end of the set time limit. If this happens, they might have to offer an additional earnest money deposit to show that they are still serious about buying the property.
But if the sale is canceled because the buyer has not secured a loan in time, then they will get their deposit back. This could also happen if the other contingencies in the contract were not met. The seller then reactivates their listing.
How Long Does a Mortgage Contingency Last?
The mortgage contingency time is agreed upon by the buyer and seller. It usually spans between 30 and 60 days like most real estate purchase agreements do. They must also specify when the official approval for the loan should be in place, which is usually a week before the target closing date.
When the buyer includes this in their offer, they must secure an acceptable loan within the set time limit. This time limit usually depends on the due diligence period and the target closing date. The due diligence period is the time after signing the sale agreement that the buyer must inspect the property. They can then make a decision on whether they want to buy the house.
A sufficient time limit is important to the buyer in case they encounter a delay in getting financed, which tends to be a common occurrence. But negotiating the contingency terms depends on several factors, mostly on the market conditions.
If you are in a buyer’s market, the seller may be more agreeable to setting a longer time limit for contingencies like this. But in the seller’s market, the buyer might have a hard time negotiating for a 60-day contingency period. Sellers would prefer buyers who either have a shorter contingency period or have waived their contingencies from the contract.
Elements of a Mortgage Contingency Clause
The mortgage contingency is not just a blanket statement. In the sale agreement, this contingency must outline certain conditions, which are mutually set by the home buyer and seller.
Type of Mortgage
You must specify the type of mortgage the buyer has to secure. It could be an FHA loan, a USDA loan, a conventional mortgage, or another type of loan. Both parties must review all of the available options before settling on the kind of mortgage that the buyer needs to get in order to move forward with the purchase.
Amount of Money Needed
This is one of the most important terms to include in your contingency clause. Specifying the dollar amount that the buyer must secure acts as secondary protection for them. If they are approved for a mortgage that is not the amount listed in the contract, they could either find another lender or cancel the sale without consequences.
Interest Rate
You can also set the maximum mortgage interest rate for which the buyer must be approved. This term is negotiated between both parties, and the buyer must be satisfied with the rate laid out in the purchase agreement. Otherwise, the buyer can back out of the sale to avoid committing to a rate that they cannot afford.
Related: Why Is the Interest Rate on Investment Property Loans Higher?
Closing or Origination Fees
Both buyer and seller need to establish the maximum costs and fees that the buyer must pay for them to secure the loan. The mortgage lender charges origination fees, which are typically 0.5% to 1% of the loan amount and include the cost of processing, underwriting, and funding the loan. It is best for the buyer to factor these additional fees into their budget so they can keep the contract.
Related: What Are the Types of Closing Costs of Investing?
Mortgage Contingency Date
This mandates how long the buyer has to secure the appropriate loan. You could set the date to be the same as the due diligence period to make things easier. The important thing is that both parties must agree on the timeframe.
In some situations, the buyer and seller may already include an extension date in the purchase agreement. This should also cover the provisions for stretching the contingency period in case the buyer has not been able to obtain the appropriate loan before the deadline. For example, you could set an amount of additional earnest money deposit that the buyer needs to make in order to secure the extension.
However, the seller is not obligated to grant an extension and can refuse to include this condition in the clause.
Waiving Mortgage Contingency
The mortgage contingency is a common clause included in real estate agreements, but buyers may choose to waive it. By relinquishing this clause, you agree to forfeit your earnest money deposit if you are not able to meet the terms in your sales contract.
Buyers usually waive this contingency if they are:
- Paying in cash;
- Using seller financing, wherein the seller handles the mortgage process instead of a financial institution;
- Preapproved for the appropriate loan, though there is still a risk for their mortgage application to be denied; or,
- If they want to make their offer look more appealing and do not mind losing their earnest money deposit, which is a usual tactic in a seller’s market.
In case the seller gets multiple offers, they would choose the one that has waived their contingencies as this will allow them to close the sale quickly.
However, waiving the mortgage contingency is risky especially for the buyer. If their mortgage application falls through after waiving this clause, they may lose their earnest money deposit and possibly incur additional fees or even get taken to court.
Other Types of Contingency Clauses
The mortgage contingency is not the only condition that you can include in the contract. Here are other common types of contingency clauses, including one that is beneficial exclusively to the seller:
Inspection Contingency
This clause mandates a clean home inspection. With this contingency, whatever the inspection unearths will help the buyer decide whether to:
- Accept the results and proceed with the purchase;
- Negotiate for concessions from the seller; or,
- Walk away from the sale.
Appraisal Contingency
This notifies the seller that the buyer intends to have the property appraised as part of their purchase. Lenders usually require this step before fully approving the mortgage. If it turns out that the home’s market value is lower than the purchase price, the buyer has several options:
- Get another appraisal to confirm the value;
- Offer a large down payment to their lender, which is usually equal to the original down payment plus the difference between the purchase price and the appraised value;
- Negotiate with the seller to lower the purchase price down to the appraised value; or,
- Back out of their purchase contract.
Title Contingency
The seller must guarantee a clear title to the property. It must be free of any liens or encumbrances. Otherwise, the buyer can cancel the sale without penalty.
Home Sale Contingency
The buyer includes this contingency if they have to sell another property in order to afford the new home. This lets them back out of the contract if they are unable to sell their previous property during the due diligence period.
Escape Clause
This is typically utilized by the seller to legally get out of a purchase agreement. When this is in the contract, the seller (with the knowledge of the buyer) may continue to market their property and consider other offers while the buyer fulfills their contingencies.
If another buyer comes in, the seller must provide a notice to the original buyer, which instructs them to either remove their contingencies and firm up their purchase or sign a mutual release.
Act Smart on Your Next Real Estate Transaction
As a home buyer, including a mortgage contingency in your offer should safeguard you in case your loan application falls through even if you are already preapproved. When setting the conditions with the seller, be sure to include the following details:
- The type of mortgage you can get
- The amount you need to loan
- The maximum interest rate you can afford
- The maximum fees you can pay
- The length of time you have to secure the loan
And if you are the home seller, you do not have to wait for 30 or 60 days to pass before finding another offer. You can include an escape clause so you can keep your listing active for better offers.
If you are ready to find your next property or sell your home, you can accomplish either by using an online platform like Mashvisor’s Property Search and Property Marketplace. Filter your search to only display homes that meet your criteria, or list your property and market it to thousands of real estate investors, real estate agents, and other serious buyers.
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