What is a mortgage contingency?

You’ve found your dream home, and now it’s time to put in an offer. But your bid is more than just how much you’re willing and able to pay for the home; it also includes contingencies — conditions that must be met for the contract to become binding.

If you’re not buying the home with cash, you’ll likely include a financing or mortgage contingency. A mortgage contingency clause in a purchase contract releases the buyer if they cannot secure financing. If the buyer can’t get a home loan, they can walk away without losing their earnest money deposit.

How does a mortgage contingency work?

Homebuyers add a mortgage contingency to their offer when they:

• aren’t paying cash
• haven’t been preapproved for a mortgage‍
• are unsure that they can obtain a loan for the full offer price

If the buyers and sellers agree to the offer, they will sign a purchase agreement, and the buyer will put down a deposit to take the property off the market.

But the deal isn’t done yet, and here’s where the contingencies kick in. The buyer now has to secure financing within the terms of the mortgage contingency.

If the buyer cannot secure the financing they need, they can terminate the contract and the seller will still return their deposit money.

Why would a buyer not qualify for a mortgage?

Just because you think you can afford a home doesn’t mean that your lenders will agree. The mortgage underwriter looks for certain things when evaluating your application, and one of the most important factors is your loan-to-value ratio (LTV). 

This ratio measures the mortgage amount against the value of your home, which will act as collateral for the loan. If your LTV is too high, your loan might not get approved or your lender may require you to get private mortgage insurance (PMI).

The most common reason for a delayed or canceled home sale contract is because an appraisal came in low. A low appraisal can tip the LTV into too risky territory for lenders. Beyond that, other issues may come up in the mortgage underwriting process, like:

• Insufficient down payment
• High debt-to-income ratio (DTI)
• Low credit score
• Not enough credit history

Learn how to get your mortgage from clear to close

How long does a mortgage contingency last?

Mortgage contingencies typically have the same lifespan as the real estate purchase agreement: 30 to 60 days. However, the length of your mortgage contingency will depend on your offer. Talk with your agent to make sure you understand when your contingency expires.

If you haven’t secured financing by the time the contingency period ends, you may request an extension from the seller. Still, there’s no guarantee they will accept — especially if the seller has had other compelling offers on their home. If the seller rejects the extension, it’s up to the buyer to decide whether to back out without any penalties or move forward and risk losing their deposit if they’re unable to secure a home loan.

What are the components of a mortgage contingency clause?

A mortgage contingency has several elements. Here’s what goes into this important part of your offer:

Mortgage contingency deadline

As discussed above, a mortgage contingency doesn’t last forever. The clause will contain a deadline by which time the conditions of the contingency must be met. Both parties — the sellers and buyers — must agree to this timeline, which is typically one to two months.

Some clauses will also stipulate an extension date, which would provide additional time for the buyers to secure financing should the sellers grant them an extension. Keep in mind, though, that the seller still has to grant the buyer an extension — just because the deadline is there doesn’t mean it’s guaranteed.

Type of mortgage

There are many types of mortgages, and most mortgage contingencies specify what kind the buyer must secure. This is because some loans come with contingencies of their own.

(For example, VA loans in most states are contingent upon the house passing a pest inspection.) Sellers who are wary of contingencies might ask buyers to specify that they will not get a loan with these additional conditions.

Total loan amount

A crucial component of a mortgage contingency is the total loan amount the buyer is responsible for. This protects buyers who may be approved for a loan less than the amount needed.

Closing costs, interest rates, and origination fees

There are additional fees associated with taking out a home loan. Mortgage contingencies may stipulate limits or maximums for these fees to protect the buyer from taking out a loan with too high of closing costs.

Should I waive my mortgage contingency clause?

In a competitive market, buyers sometimes waive contingencies to make their offer more attractive to sellers. The May 2022 Realtors Confidence Index Survey revealed that dropping contingencies is a popular choice in today’s seller’s market. 25% of buyers made all-cash offers — which don’t require a financing contingency — while 26% of buyers waived the home inspection contingency, and 24% waived the appraisal contingency.

Here are some scenarios where waiving the contingency clause might make sense:

• The buyer is paying cash. If you don’t need financing, there’s no need to include a mortgage contingency as a part of your offer. You’re already protected because you have the money in the bank.
• The buyer is using seller financing. In this type of transaction, the buyer agrees to pay the seller in installments instead of securing a loan, effectively cutting out the middleman of the lender. It can be a good way to save on closing costs but comes with the risk of fewer regulations and protections. However, because a lender is involved, there’s no need for a mortgage contingency clause.
• The buyer is prequalified or preapproved for a loan. Keep in mind, though, that some loans have their own contingencies. Double-check any contingencies the buyer’s pre-approval might have before waiving the mortgage contingency clause.
• The buyer is comfortable losing their deposit if they can’t get a loan. The average person earning $60,000 per year will have to set aside 20% of their income for four years to save enough money to buy a home. If the house is worth the risk of losing your hard-earned money, then you could waive your mortgage contingency.

There’s a way to have the advantages of a non-contingent offer without the risk of losing your earnest money deposit. Drop the contingencies and become a cash buyer when you work with Orchard.