Why a Home Buyer Should Request a Loan Contingency

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Having a loan contingency clause in a home sales contract ensures that the buyer can get out of the purchase contract if something goes wrong in the loan approval or home inspection process. A buyer should make sure a loan contingency—also called a mortgage or financing contingency—is in their contract if they aren't sure they will be able to obtain a home loan.

This kind of clause may also include the amount of the down payment the buyer will make and the type of mortgage the buyer hopes to obtain. It should cite the length of the loan and its interest rate. Adding these items will protect buyers from losing their deposit if they can't obtain a mortgage as laid out in the purchase contract.

Cancel an Offer Without Losing Earnest Money

The types of purchase contracts used in the U.S. can vary from one state to another, but most allow for a loan contingency period during which the buyer must obtain the money they need to complete the home purchase. A buyer might be required to tell the seller that they haven't gotten a mortgage at least 30 days before the sale is scheduled to close. Either party can then end the contract.

An earnest money deposit is held by the agent or broker at the time a buyer makes an offer to purchase the home. It's usually payable to a title or escrow company or the brokerage. The amount of the deposit is credited to the buyer at closing.

The buyer can cancel the contract without losing their earnest money deposit if they're unable to obtain a mortgage and they tell the seller within the agreed period of time. If this does not happen, the contract moves forward and the earnest money is moved into a special account where it will stay until closing.

A buyer should make a good faith effort to secure financing. They must submit a loan application and cooperate with the lender to provide all requested documentation so the loan can be approved. Some states stipulate that the loan amount must be no more than is required to finance the home.

Active vs. Passive Contingency Removal

The removal of a loan contingency from the contract can happen in one of two ways.

An active contingency means that the buyer has placed some things on the purchase contract that must be done before the home closes escrow. This could be getting the money to buy the house, the house passing inspection, or any other number of things. These contingencies are removed once they are satisfied.

The seller might issue a "Notice to Buyer to Perform" (NBP) in some states when the contingency period has expired. This puts the buyer on notice that time is running out. The seller is free to cancel the contract after this time has passed if the buyer is unsuccessful in securing a loan.

If the date has passed and the buyer hasn't been able to obtain financing and has failed to notify the seller, the contingency is removed. This type of removal is passive, and the buyer can still be contractually obligated to buy the home. The buyer could lose their earnest money and leave themselves open to a lawsuit by the seller if the contingency simply expires.

Requesting an Extension

The buyer might still want to purchase the house after an active loan contingency has been removed. They might continue to try to secure financing for the purchase. They can request more time to get a mortgage, but the seller is under no obligation to agree to an extension. The buyer might be required to put down more earnest money in exchange for extra time.

A loan contingency clause could contain a downside for the buyer. A buyer should pay close attention to what they are supposed to do under the terms of the contingency. They might be obligated to purchase the home even if they've been unable to obtain a loan.

Key Takeaways

  • A loan contingency clause in a sales contract can protect the buyer from having to purchase a home when they have been unable to get a mortgage.
  • A buyer must make a good faith effort to secure financing in order to cancel without losing an earnest money deposit.
  • The buyer might still want to purchase the house after a loan contingency has been removed, and they might continue to try to secure money for the purchase.
  • They can request more time to get a mortgage, but the seller is under no obligation to agree to an extension.