Mortgage Contingency Clause in Real Estate Home Purchase Contract

A mortgage contingency clause, also known as a loan contingency clause, is considered one of the most important purchase contract provisions for the potential buyer of real property. Its only contender for essential buyer provisions is the home inspection contingency. A mortgage contingency clause is a provision in the home purchase contract saying that if the prospective buyer cannot get a mortgage within a fixed period of time with the specified terms, the buyer can call off the whole deal and get back his deposit. The agreement with the seller is therefore conditional on the buyer being able to obtain a mortgage on the property. If the borrower is unable to obtain a firm commitment from a lender for the loan to buy the property in a set time period, the buyer has the option to not close the sale and is entitled to a refund of his full down payment.

Active Contingency Provision

Typical terms in a purchase contract include an active contingency waiver. This contingency waiver is a provision in a contract requiring the buyer in writing to “cancel” a specified condition such as a loan financing commitment for the property’s purchase, for the sale to go forward. Sentiment is that a buyer should always have an active contingency waiver in the purchase agreement because the buyer is in control of releasing the contingency.

Passive Loan Contingency

An example of a passive loan contingency is "buyer will close escrow on the designated property on the date agreed upon unless the buyer within 25 days before the agreed upon date to close escrow notifies seller in writing that buyer has no loan commitment by a lender to purchase the property". In this situation, if the buyer fails to give notice to the seller that he has no loan financing commitment by the agreed upon date, the buyer is bound to buy the property without financing in place. Many times a buyer will not carefully read the purchase agreement containing a passive contingency waiver with a deadline. If the designated contingency (i.e., loan commitment approval) is no longer applicable, but the buyer does not remove the financing contingency, the buyer is on the hook. If the buyer fails to advise the seller that he is not waiving the loan commitment contingency in writing, the safeguard for the loan commitment is lost and the buyer would be required to buy the property even if he does not have committed financing in place. Many times the buyer and his/her real estate agent simply forget about the passive contingency, the time to stop its release passes, and the buyer is then stuck. This obviously can lead to serious problems for the buyer.

Requesting a Commitment Letter

The buyer should request a commitment letter rather than a pre-approval letter from the lender. A pre-approval letter to the borrower is not binding as opposed to the lender's commitment letter stating the agreed upon terms of the approved loan. Consequently it is important for any borrower to have a loan contingency clause in his offer which requires a lender's commitment letter as a condition to purchase the desired property.

Requesting a Loan Contingency Clause

The buyer should always request a loan contingency clause for protection if financing is needed to close the sale. The seller typically prefers to avoid such a contingency because the sale may be delayed due to the loan approval process. The seller may even be required to find an alternate buyer if the buyer cannot obtain loan approval.

Seller's Reluctance

The seller's acceptance of the loan contingency clause as a condition for the property’s sale depends upon numerous factors including a strong seller’s or buyer's real estate market, a strong lender’s market, the appraised value of the property, the amount of the loan, and the financial strength of the buyer. For example, in a strong buyer’s market, the seller is faced with few offers for his property at the price desired and consequently will be more willing to accept a loan contingency as a condition for the sale as opposed to a strong seller’s market where the seller is faced with multiple offers to purchase typically above the initial asking price. In a weak seller’s market scenario, the seller most likely will be forced to accept a loan contingency for the sale to go through or risk the possible sale of the property. In most loan contingency provisions, the seller wants the shortest possible period for approval, while the buyer wants the longest possible period. In any event, the buyer should insist upon a commitment letter by the lender as part of the loan contingency agreement to ensure that he gets the loan before waiving this contingency. The best course of action for the buyer is to have up to the escrow signing date to formally waive the loan contingency, to ensure that the sale will close or not, and if not, to safeguard against the loss of the deposit.

Negotiating a Mortgage Contingency Clause

Since there is no standard mortgage contingency clause, the provisions are usually negotiated between buyer and seller. The seller would prefer that the sale close no matter how high the interest rate and how horrible the mortgage terms are for the buyer. The buyer wants to be sure that if he cannot get the mortgage he is counting on, such as one with 90% financing on a 30-year loan, with the mortgage at no more than X%, that he can walk away from the transaction and recover the down payment. The seller may be concerned that the buyer is leaving the transaction too uncertain. Thus buyer and seller often compromise on the terms of the provision.