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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.
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.
Image by Daniel Bertsche /Flickr
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.
Never leave home without one
You may decide to forgo the mortgage contingency in the belief it makes your offer stronger, particularly in a seller’s market. Resist this urge, 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.
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.
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Types of contingency clauses
We have seen that there is flexibility with the mortgage 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.
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, and attorney.