A mortgage contingency clause provides the buyer with crucial protection. Many sellers frown upon contingencies since it complicates the process and puts the deal at risk should financing not be obtained. However, it is typical to include this clause in a real estate purchase contract. You should fully understand this contingency and how it protects you, the buyer. It is particularly useful if you are a first time home purchaser, and you have never been through the buying process.
There are also times when buyers may wish to waive their mortgage contingency clause. With New York City inventory tight, you can help level the field with all-cash offers by doing so. However, we advise using it judiciously since there are pitfalls that you need to be aware of given you are risking your down payment.
We explain the mortgage contingency clause, and when it is advisable to use it to bolster your offer.
What is a mortgage contingency?
The mortgage contingency provides the buyer with a certain amount of time to obtain a mortgage. If the lender denies the mortgage, the buyer does not have to proceed with the purchase and is entitled to a full refund of the contract deposit.
The standard time for the purchaser to get a mortgage commitment is thirty days or sixty days. This may seem to be a quick turnaround. Therefore, it is incumbent upon you to speak to your lender before signing the contract and keep in contact throughout the process. Any paperwork requested by the lender should be sent back promptly to keep things moving. Asking for a few extra days does not usually present a problem, but it is advisable not to go past this or have to ask for a second extension.
Once you agree to the terms, a mortgage contingency is a standard part of the contract. Otherwise, he/she can back out of the deal without penalty, and any money paid to date gets refunded.
There are a couple of caveats that usually apply. The buyer must make a “good faith” effort to obtain a loan, filling out the loan application accurately, and following through with a bank’s requested information promptly.
Once the bank approves your loan application, the buyer has to go through with the purchase, unless there are other contingencies in place.
Types of contingency clauses
We have seen that there is flexibility with the contingency clause. Aside from that, there is the active contingency provision, passive loan contingency, and a hybrid.
The active contingency gives the buyer more control. It requires the buyer, in writing, to waive certain conditions for the deal to go through.
A passive contingency is more stringent and less favorable to the buyer. For instance, it could require the buyer to notify the seller at a particular time that he has not obtained a mortgage. Failure to do so puts the buyer on the hook to purchase the property, even if there is no mortgage. A hybrid contingency is a middle ground, as the name suggests. Buyers agree to forfeit a portion of the deposit. The wording of the mortgage contingency is crucial.
In a seller’s market, if a bidding war breaks out, you can propose a mortgage contingency for the sales price. If the appraisal falls below the sales contract price, the buyer would promise to cover the shortfall. Alternatively, the wording could allow the buyer to walk away, or this may serve as an impetus to renegotiate the deal.
When to waive your right
You may decide to waive the mortgage contingency in the belief it makes your offer stronger, particularly in a seller’s market. Resist this urge if possible, even if you feel confident, particularly if you have been pre-approved. However, a loan pre-approval is non-binding, and other factors may come into play. Moreover, credit conditions can change, and this clause protects you in such an event. You will be able to void the sales contract without penalty, providing a good faith effort has been made during the specified time.
While a contingency is in place to protect the buyer, there are times when you should consider waiving this right. You should do this only when you really want the property; it is very desirable, and, therefore, you find yourself in a competitive bidding situation. We recently discussed “best and final” offer situations where you can strengthen your offer by placing fewer contingencies.
If you are competing with all-cash bids, waiving your contingency makes your offer more competitive. Of course, if the seller receives a cash offer with an easy close and no conditions, which is also higher than your bid, you do not stand much of a chance.
The seller, naturally, wants the deal to close. He is indifferent to the level of interest rate you will have to pay, or if the other terms are onerous. The buyer may want to ensure a deal only if he can receive certain favorable mortgage terms. For instance, a 30-year mortgage rate below 6% might be the contingency. There is a compromise, but it is important to have one included unless you are an all-cash buyer or putting down a deposit of 50%. Otherwise, you risk losing the 10%-20% deposit you have put down.
What’s at risk?
You need confidence that you will be able to obtain a mortgage within the prescribed time frame. If you fail to do so, you risk forking over your deposit to the seller, which easily could be a five or even a six-figure amount.
Obtaining pre-approval can mitigate your risk greatly. However, a change in the economy (causing lending standards to tighten) or your employment situation could cause the bank to balk at extending you the loan. In this case, a backup plan where you have alternative sources of financing, borrowing from friends/relatives or tapping your retirement plan, is handy.
The lender could also come in with a lower than expected appraisal. In this case, the bank will only extend you a certain amount of credit. It is then up to you to come up with the additional funds.
It’s not all-or-nothing
You do not have to waive the mortgage contingency entirely. You can put in that you have to obtain a mortgage unless the bank refuses to make the loan due to circumstances beyond the buyer’s direct control, such as his/her financial position. However, this does not put you in as strong a position than entirely waiving the mortgage contingency clause.
If you choose to waive the contingency, we advise keeping it in place based on the building. You may be confident in your ability to obtain a mortgage based on your credit and financials, but the bank also has to extend the loan based on the building. It could deny the loan based on any number of circumstances. These include the building’s poor financials, liens, litigation, or even if the sponsor holds too many units.
While this may not put you in as strong a position, this protects you from events outside of your control.
The tide turned in New York City’s housing market several years ago. You may feel you have found the perfect home, and are at risk of losing it. However, the mortgage contingency clause is there for your protection. Before choosing to forgo a contingency that could get you in severe financial straits down the road, consult your lender, buyers agent, an attorney.