Mortgage 101

What Is a Loan Contingency?

Published on: February 11, 2022

loan contingency

Adding a loan contingency to a home purchase offer can help ensure that you’re protected and have a way out of the contract, if needed. Buying a home is a huge financial investment, after all. That’s why many home purchase contracts include loan contingency clauses that give homebuyers an escape hatch if they aren’t approved for a mortgage or other conditions aren’t met.

Here’s a look at what loan contingencies are, how they protect buyers, and whether this failsafe should ever be waived.

What is a loan contingency and how does it protect you?

When making an offer on a home, you have the option to include contingencies into your contract. A contingency is a term or condition that provides you with an option to back out of the purchase contract with little to no financial penalty if certain conditions aren’t met. A mortgage loan contingency enables a buyer to back out of their contract if their mortgage funding falls through.

While a loan contingency is intended to allow the buyer to back out of the purchase, it really protects both parties. The seller is protected if the buyer cannot get mortgage funding within a reasonable period of time. Instead of waiting on a loan to go through, the seller can back out of the agreement and sell the property to another buyer.

Other common contingencies include the home inspection revealing concerning issues, or if the home doesn’t appraise for the purchase price. Buyers can also opt for a home sale contingency, which means their existing home must sell before they close on their next place.

In addition to allowing someone to back out of buying a home, a loan contingency clause can also save buyers from losing money. When a buyer’s offer is approved, they are typically required to make an earnest deposit to the seller’s title company, which can range from a few hundred dollars to a few thousand dollars. However, if the buyer backs out of the sale without any contingencies, the earnest money could be forfeited to the seller. With a loan contingency, though, the buyer will receive their earnest money deposit back even if they cancel the purchase.

How long do loan contingencies last?

While loan contingency periods can vary depending on the terms of the purchase agreement and state laws, many mortgage contingencies last 30 to 60 days after an offer is accepted. Inspection contingencies may range from seven to 14 days or beyond.

Different contingencies on the same purchase contract may be removed or expire at different times, as well. For example, the buyer may have up to 14 days to back out of the contract due to home inspection-related issues but be given 30 days to get final mortgage approval and funding. There is typically a small gap between the mortgage contingency date versus the closing date on the loan. While this time frame may vary, the buyer will need to finalize funding at least three business days prior to the scheduled closing date to receive the required closing disclosure form from their lender.

Active vs. passive loan contingency removal

It is possible to remove a loan contingency after the contract is in place. Loan contingency removal can either be active or passive in nature. With a passive contingency removal, the contingency deadline typically passes without being met or extended; if the buyer has not canceled the contract by this time, the contingency simply falls off and the terms of the purchase contract remain in effect.

For example, let’s say a buyer’s mortgage contingency date passes and they have not been able to secure funding (or notified the seller). In this case, the contingency passively falls off the contract. The buyer may then lose their earnest money if they back out of the purchase or could open themselves up legal action if they try to back out of the deal.

An active contingency, however, requires the party to actively remove their contingency, even if the date has passed. This may be the case with an inspection or appraisal contingency. If a buyer is unable to get a report completed in time or needs additional time to consider the results, the contingency often stays in place even after the period ends.

If a buyer needs to extend their loan contingency period, they can request to do so. This usually involves submitting an amendment to the contract, in writing, to the seller — which they can choose to approve or deny. In some cases, the seller may also require that the buyer pay additional earnest money or an option fee to extend the contingency period.

Waiving your loan contingency: Is it a good idea?

In a competitive market where sellers have an upper hand, buyers may find themselves fighting for their dream home or to get their offer accepted. Sometimes, it can be tempting to waive any loan contingencies in order to make an offer more lucrative and enticing to the seller. But this choice comes with some downsides.

Waiving a loan contingency can make an offer stand out to a seller and can even be used as a bargaining chip. This might mean getting a seller to agree to a lower sales price or even having them cover a portion of the closing costs.

However, by waiving a loan contingency, buyers leave themselves with limited recourse to walk away from the transaction. For example, if there is no loan contingency and the buyer’s mortgage financing falls through during the mortgage process for any reason, the seller could keep any earnest money deposit and even potentially sue the buyer for failing to close on the home as agreed.

Waiving the mortgage financing contingency may make more sense for cash buyers or buyers who’ve been approved for a mortgage upfront, also known as upfront underwriting. Finance of America Mortgage offers this option, called HeadStart Underwriting.

Without an inspection contingency, buyers may be stuck with costly repairs if the home has serious defects revealed in the home inspection report. And if your new home appraises for less than your agreed purchase price, the lack of an appraisal contingency may mean losing earnest money by backing out of the sale. You might also have to come up with the difference in cash at closing.

Mortgage loan contingency FAQs

Can a seller back out of a contingent offer?

A seller can back out of a contingency purchase offer if certain contingencies are not met or contingency dates pass. For instance, if a buyer’s mortgage finance contingency date passes and they are unable to obtain funding, both parties can walk away from the contract without loss or liability.

What’s the difference between sale pending and sale contingent?

A sale-contingent property is one where a seller and buyer have agreed to a purchase contract, but the sale is contingent on certain factors, such as mortgage financing or a home inspection. Once these dates pass or the contingencies are actively removed, the home is considered sale pending until close.

If you’re ready to learn more about your home loan options, talk to a local Finance of America Mortgage Advisor today.

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