Home Buying Loan Contingency Tips
Try Not to Lose Your Loan Contingency
When I bought my first home that required institutional financing, I made sure that the purchase contract contained a loan contingency. Having a loan contingency in the contract meant if any little thing went wrong with the purchase of my new home and for some reason, whatever odd reason that the lender could not make a loan for me, then I would be released from my obligation to buy the home.
Up until that point, all the homes I had ever purchased were bought through owner financing. There was no loan contingency in a seller-carried mortgage or land contract. Once I signed the purchase contract, I was pretty much required to go through with the sale of the home, with the exception of an inspection contingency. There was also no appraisal contingency with owner financing.
During times of low-interest rates, owner financing falls out of favor and few people, except the credit challenged, try to use owner financing to buy a home. Another exception might be if the home itself does not qualify for financing, then a seller might consider owner financing. But most sellers in normal real estate markets prefer that a buyer either pay cash or obtain a loan to purchase a home.
Purchase Contracts with a Loan Contingency
The types of purchase contracts used in the United States varies from one state to another, but most of them will allow for a loan contingency period. In addition to the loan contingency, the residential purchase agreement such as those used in California, for example, might also contain an appraisal contingency, which is separate from the loan contingency.
Purchase contracts generally provide a certain number of days by contract default to receive assurance that the loan is approved and the buyer will be allowed to use financing. That time period can range from 7 to 30 days, with many periods pushed toward the 3- to 4-week mark. This is why it is paramount for a home buyer to deliver all of the loan documents that a loan officer requests as quickly as possible. Any delay in submitting the required financial documents could cause a delay in the final loan approval.
When the Loan Contingency Expires
In some states, once the loan contingency period has expired, the buyer is out of time. If the buyer's loan is not approved during that time period, that's too bad. The buyer can ask for an extension, but sellers are not always required to allow it. TIP: Don't make the mistake of thinking that you have all the time in the world to give your lender copies of your tax returns and to provide all of your banking information because the clock is often ticking.
In other states such as California where the purchase contracts tend to favor the buyer, if the buyer does not remove the loan contingency on the final day, the seller can take steps to cancel the contract after issuing a Notice to Perform. If the seller does not take any legal steps to enforce the contingency period, it remains. It's not a good idea to hope that the seller in California will waive the loan contingency because most sellers are represented by listing agents who will remind them of their rights under the contract.
I often get a lot of resistance from buyer's agents when as a listing agent I request a release of the loan contingency from the buyer. They ask for more time or, in some cases, they blow it off altogether because, for whatever reason, maybe they don't feel like pushing their buyers to adhere to the contract. If buyers need more time, though, we aren't allowed to give our verbal OK because our California contracts allow a buyer to submit only a formal written request for more time. All contracts and agreements should be in writing for everybody's protection.
What Happens if Underwriting Denies the Loan?
The question that often arises is what can happen to a buyer who is not approved for a loan but has either released the loan contingency or for whatever reason has lost the loan contingency protection in the purchase contract. Can a seller sue the buyer? Will the buyer lose her earnest money deposit? What is it at risk?
The risk factor and the consequences vary from state to state. A lot can go wrong in underwriting. Home buyers who think they are approved for a loan because their lender gave them a pre-approval letter based on a loan application can later discover that underwriting will not approve the loan. There are really no such things as slam-dunk mortgage loans. Many reasons exist for underwriting to reject a loan. Those home buyers who have a loan contingency typically can cancel the contract and receive a refund of their earnest money deposit.
If home buyers cannot get a loan due to the appraisal contingency, because the appraisal came in low and the seller will not reduce the purchase price, that is typically also grounds to cancel. But to be completely protected in these circumstances, you've gotta have a loan contingency and an appraisal contingency in place. Be sure to talk to your real estate agent before signing a purchase contract to obtain a firm understanding of how a loan contingency works in your state.
At the time of writing, Elizabeth Weintraub, BRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California