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When buying a home, few clauses are as important, or as misunderstood, as the financing contingency. This protective clause in your purchase agreement can save you thousands if your mortgage falls through, but in today’s competitive market, some buyers are tempted to waive it.
Whether it’s your first time buying a home in Seattle, WA or you’re looking to invest in a condo in Austin, TX, understanding how a financing contingency works can help you navigate the process and avoid costly mistakes. In this Redfin article, we’ll break down exactly what a financing contingency is, why it’s important, and how it can protect you throughout the homebuying process.
What is a financing contingency in real estate?
Quick answer: A financing contingency gives buyers a way to walk away from the deal – and keep their deposit – if their loan application is denied.
A financing contingency is a clause in a home purchase agreement that allows the buyer to cancel the deal without penalty if they’re unable to secure a mortgage within a set timeframe. It protects the buyer’s earnest money and limits their financial risk if their financing falls through.
Even if you’ve been pre-approved, things like a low appraisal, a job loss, or changes in your credit can derail the loan process. This contingency gives you a legal out if something unexpected prevents you from closing.
Situations where waiving your financing contingency may be riskier
Even in a competitive market, there are situations where waiving this protection could put you at serious financial risk. You may want to keep the financing contingency in place if:
- You’re a first-time homebuyer. If you haven’t gone through the mortgage process before, you may not be aware of potential delays or surprises that can derail financing.
- You have a low down payment. Smaller down payments may trigger stricter lender requirements or private mortgage insurance (PMI), increasing the chance of financing issues.
- Your income is variable or recently changed. If you’re self-employed, just changed jobs, or have inconsistent income, lenders may take longer to approve your loan—or deny it altogether.
- You’re buying a unique or hard-to-appraise property. Unusual homes can cause appraisal challenges that impact loan approval.
- You’re using a government-backed loan. FHA or VA loans often have longer processing times and stricter property standards, which could create unexpected delays.
In these cases, keeping the financing contingency gives you critical protection if something doesn’t go as planned.
Situations where waiving your financing contingency may make sense
In hot housing markets, buyers sometimes waive contingencies to strengthen their offer, but that comes with risk. Here are a few scenarios where waiving your financing contingency might make sense:
- You’re paying in cash. If you’re not relying on a mortgage to finance the home, the financing contingency becomes irrelevant. Cash buyers have a significant advantage in a competitive market because they eliminate the risk of financing falling through.
- You have a strong pre-approval. If your lender has already given you a solid pre-approval, you may feel confident that your loan will be finalized. Strong pre-approvals often come with assurances that your financing is nearly certain, reducing the risk of backing out.
- You’re making a large down payment. A substantial down payment can reduce the chances of financing complications. Lenders may see buyers with larger down payments as lower risk, making the loan process smoother and more likely to close without issues.
- You’re confident in your financial situation. If you’re in a stable job, have a high credit score, and have no significant changes expected to your financial situation, you might be more comfortable waiving the contingency, as the chances of your financing falling through are low.
Even if one or more of these factors apply to you, waiving a financing contingency still carries risks. If your loan falls through, you could lose your earnest money or even be legally obligated to follow through with the purchase. For this reason, it’s essential to evaluate your situation and the market conditions carefully before deciding to waive this common contingency.
How to protect yourself if you waive the financing contingency
If you decide to waive this clause, here are a few ways to lower your risk:
- Work with a reliable lender: Partnering with a lender known for efficiently closing loans can help avoid issues later in the process.
- Increase the down payment: A larger down payment can improve the chances of loan approval and lower the risk of financing falling through.
- Have a backup plan: In the event that financing is not secured, having alternative options such as a bridge loan or private lending in place can help protect the buyer.
What’s included in a financing contingency?
Financing contingencies vary, but most include the following key terms:
Timeframe: Usually 30 to 60 days to secure financing. If the buyer can’t get a loan by the deadline and hasn’t requested an extension, they risk losing their earnest money.
Loan type: Specifies whether the buyer is using a conventional, FHA, VA, or jumbo loan. This matters because each loan type has different requirements and approval timelines.
Loan amount: The buyer must be approved for a loan amount that covers the purchase price. If the loan comes in short (often due to a low appraisal) they may need to renegotiate or walk away.
Interest rate cap: Some contingencies include a maximum acceptable interest rate. If mortgage interest rates spike above that number, the buyer can cancel the deal.
Earnest money protection: This is the core of the clause – it ensures the buyer can walk away and keep their earnest money deposit if financing falls through.
Closing costs: Occasionally, this section outlines who pays which closing costs, though that’s often negotiated separately.
How does a financing contingency work?
Once a seller accepts an offer, the financing contingency period begins. During this time, the buyer must:
1. Apply for a mortgage: Submit a formal loan application to a lender.
2. Provide financial documentation: This includes tax returns, pay stubs, credit reports, and other necessary documents.
3. Receive lender approval: The lender reviews the application and provides either pre-approval or a mortgage commitment letter.
4. Finalize underwriting: The lender verifies all financial details and conducts an appraisal of the property.
If the loan is approved within the contingency period, the sale proceeds. However, if the financing falls through, the buyer has several options:
1. Request an extension: If more time is required to secure financing, the buyer can ask the seller for an extension. The seller may accept or reject the extension.
2. Seek alternative financing: The buyer may pursue different lenders or loan types.
3. Cancel the contract: The buyer may choose to walk away without losing their earnest money.
Why the financing contingency matters
This clause isn’t just a formality, it’s a vital protection for buyers who are using a loan to purchase a home. Without it, a buyer could:
- Lose thousands in earnest money
- Be legally required to close without financing
- Face lawsuits for breach of contract
In competitive markets, it’s tempting to waive this clause, but doing so without a solid financial plan can backfire.
Real-world example
Sarah waived her financing contingency to win a bidding war. But when the appraisal came in $40,000 below the purchase price, her lender reduced the loan amount. Sarah didn’t have enough cash to cover the difference and ended up losing her $10,000 deposit when she couldn’t close on the home sale.
Financing contingency FAQs
How long does a financing contingency last?
A financing contingency typically lasts 30 to 60 days, giving the buyer time to secure a mortgage approval. If the buyer is pre-approved, the process may move faster, possibly shortening the contingency period. However, if more time is needed or unexpected issues arise, the buyer can request an extension, but this depends on the seller’s approval. If financing isn’t secured by the end of the contingency period, the buyer can cancel the deal and walk away with their earnest money, as long as the terms of the contingency are met.
What happens if the financing contingency period expires without securing a loan?
If the buyer is unable to secure financing by the end of the contingency period and does not have an extension in place, they can walk away from the deal without losing their earnest money, as long as the financing contingency terms are met. However, the buyer must notify the seller that they are backing out due to financing issues. After the contingency expires, the buyer may no longer have the option to cancel for financing reasons.
Can a buyer renegotiate the terms of the loan during the financing contingency period?
Yes, during the financing contingency period, if the buyer faces issues with the loan, such as a lower-than-expected appraisal or a change in interest rates, they may try to renegotiate the terms with the seller. In some cases, they may ask the seller to lower the purchase price or offer concessions to make the loan more affordable. However, the seller is not obligated to agree to these changes.
What happens if a buyer’s financing falls through after the contingency period?
If the buyer’s financing falls through after the contingency period has ended, they are typically in breach of contract. Without the protection of a financing contingency, the buyer risks losing their earnest money and may be required to proceed with the purchase or face legal consequences. It’s essential for buyers to meet the terms of the contingency and secure financing within the set timeframe to avoid this scenario.