If you have recently entered the housing market or purchased a home, you may have heard about a lending concept known as the mortgage contingency. A mortgage contingency is a clause in the home sale contract that makes the buyer’s purchase of the home contingent on securing financing, such as a mortgage or a deed of trust.
Mortgage contingency clauses are designed to protect both the home seller and the home buyer from uncertainty in the home sale transaction. While the mortgage contingency is a simple concept to understand, there are subtle nuances that all home buyers should be aware of.
This article will attempt to better explain mortgage contingencies so that the average home buyer will know what it is and what its purpose is.
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The Mortgage Contingency Defined
The mortgage contingency clause provides protection to the buyer of real property by conditioning the purchase upon being able to successfully obtain a mortgage for the purchase.
With certain exceptions, if the buyer is unable to obtain a mortgage for the purchase, the buyer has the ability to cancel the contract and receive a full refund of the down payment.
While every situation is different, most normal home sales contracts will come with a contingency clause unless the purchase is a cash purchase. Purchases of property with cash or other types of readily available liquid capital (Bitcoin or other crypto currencies, for example) do not require mortgage contingency clauses.
The clause provides for a fixed period of time with specified terms during which the mortgage must be applied for and pursued in good faith. Usually, the contingency period will last anywhere between 30 and 60 days.
If the buyer does not cooperate with the mortgage process and the sellers can show proof of that non-cooperation, the buyer runs the risk of losing the protection of this clause and therefore losing the down payment funds.
Types of Mortgage Contingency Agreements
Two types of mortgage contingency agreements are commonly inserted into real estate purchase contracts: passive contingency provisions and active contingency provisions. Active contingency provisions are uncommon in New York.
Where the mortgage contingency provision is active, the buyer has control over when the provision is dismissed. To eliminate the contingency, the buyer must notify the seller of his or her intent to terminate the contingency provision before the contract can move forward.
If the contingency is not lifted before the deadline, the buyer can still recover his or her deposit before the seller.
Passive contingency provisions are the norm in New York. Passive contingency provisions work on a strict deadline basis, giving the buyer a set amount of time to secure financing before the contingency expires.
The buyer will still be bound to purchase the home if the buyer fails to notify the seller that he has been denied financing within the deadline provided for in the contingency provision.
However, if the buyer informs the seller of their denial for financing before the contingency term expiration, the buyer will not be forced to forfeit his or her deposit payment.
The Importance of the Mortgage Contingency to the Homebuyer
At Law Office of Yuriy Moshes, we always advise our clients that they should ask for a mortgage contingency clause in all home purchase contracts. In many cases, both the buyer and seller will benefit from a mortgage contingency clause. This is because it gives both the buyer and the seller the ability to walk away from the contract without any penalties if the buyer cannot acquire the necessary financing.
A buyer may have a mortgage pre-approval when they make an offer on a property, but they cannot actually be approved until their lender verifies a number of factors about the buyer, as well as about the property being purchased.
Since the buyer usually does not have an actual mortgage commitment when the purchase contract is signed, this clause is meant to protect both the buyer and the seller in the event that the buyer is not approved for the mortgage, giving the buyer the right to a refund of his down payment proceeds and allowing the seller to avoid needless litigation.
While a real estate contract should always include a mortgage contingency clause, some sellers will not agree to mortgage contingency clauses.
In today’s hot real estate market, many sellers are opting to not accept any offers to purchase with any type of mortgage contingency clause. This allows sellers to close faster or keep down payment funds if financing falls through. Additionally, real estate agents can use the mortgage contingency as part of their listing presentation.
If the real estate agent is confident enough in the ability to sell a property quickly, the agent may propose to the seller that the agent will sell the property with no contingencies at all.
We do not recommend entering into a home sale contract that does not contain a mortgage contingency clause, but if your dream home is on the line, forfeiting the protections of the mortgage contingency may be necessary, but only if you are purchasing with cash.
If you are considering foregoing the protections of the mortgage contingency, you should consult an attorney about your decision.
The Consequences of Waiving Your Mortgage Contingency
Waiving your mortgage contingency can result in the buyer forfeiting his or her earnest money deposit if the terms in the sales contract are not met. In most cases, this will occur because the buyer was unable to obtain financing.
A contingency waiver may make sense if you want your offer to appear more attractive to the seller. This may be a useful tactic in a seller’s market, where a homeowner might receive multiple offers at once.
However, waiving the mortgage contingency clause introduces significant risks into the equation. Once the seller agrees to a contingency-free sale, backing out at any point means forfeiting any earnest money you provide.
You should never assume that you will succeed in getting financing for your purchase. Lenders will refuse to extend mortgage loans for many different reasons. The most common reason for a refusal of a large home purchase mortgage is a combination of poor credit and a lack of a prior relationship with the lender.
If a buyer seeking a mortgage has low credit, the lender has no reason to trust the buyer’s ability to pay back the loan if there is no prior relationship. Even if you believe your credit is good; however, a lender could still refuse financing, especially if your income does not appear to match the repayment terms of the loan.
Negotiating a Mortgage Contingency Clause
When the home buyer and the home seller sit down to draft a home purchase/sale contract, the buyer should always request a loan contingency clause.
Many sellers will agree to such a clause automatically because it is a standard form clause in most real estate contracts; however, some sellers may be reluctant to include such a clause for various reasons.
Sellers tend to be reluctant to agree to mortgage contingency clauses for two reasons.
First, in a seller’s market, the seller may become anxious about turning away subsequent bidders who are willing to pay a higher price than the buyer’s amount agreed to in the contract.
Second, the mortgage approval process takes time, and many sellers will refuse mortgage contingency clauses simply because they want to have the certainty that their home will sell.
In negotiating with the seller, it is always important to remind the seller that the mortgage contingency clause benefits both parties. The mortgage contingency clause gives the seller certainty that when the contract is signed that either the buyer will pay or neither party will face any penalties.
Satisfying the Mortgage Contingency Requirement: Lender Commitment Letters
As a general rule, the buyer must request a commitment letter from the lender to show that the buyer actually has the financing necessary to satisfy the mortgage contingency requirement.
A pre-approval letter is not enough to satisfy the mortgage contingency requirement because pre-approval for a mortgage is not a mortgage commitment. The lender can still refuse to provide financing even if the buyer has been pre-approved.
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This is because the pre-approval process involves only a cursory review of the buyer’s financial situation. The lender will want to conduct a more thorough examination before agreeing to provide a mortgage.
An example of the mortgage contingency
The following is an example of a mortgage contingency clause that you may find in a purchase contract. The exact terms of the contract will differ as they must be agreed upon by both buyer and seller.
Mortgage Commitment Contingency
* The obligation of Purchaser to purchase under this contract is conditioned upon issuance, on or before days after a fully executed copy of this contract is given to Purchaser or Purchaser’s attorney in the manner set forth in paragraph 25 or subparagraph 8(j) (the “Commitment Date”),
of a written commitment from an Institutional Lender pursuant to which such Institutional Lender agrees to make a first mortgage loan, other than a VA, FHA or other governmentally insured loan,
to Purchaser, at Purchaser’s sole cost and expense, of $ for a term of at least years (or such lesser sum or shorter term as Purchaser shall be willing to accept) at the prevailing fixed or adjustable rate of interest and on other customary commitment terms (the “Commitment”).
To the extent a Commitment is conditioned on the sale of Purchaser’s current home, payment of any outstanding debt, no material adverse change in Purchaser’s financial condition or any other customary conditions,
Purchaser accepts the risk that such conditions may not be met; however, a commitment conditioned on the Institutional Lender’s approval of an appraisal shall not be deemed a “Commitment” hereunder until an appraisal is approved (and if that does not occur before the Commitment Date Purchaser may cancel under subparagraph 8(e) unless the Commitment Date is extended).
Purchaser’s obligations hereunder are conditioned only on issuance of a Commitment. Once a Commitment is issued, Purchaser is bound under this contract even if the lender fails or refuses to fund the loan for any reason.
* Purchaser shall (i) make prompt application to one or, at Purchaser’s election, more than one Institutional Lender for such mortgage loan, (ii) furnish accurate and complete information regarding Purchaser and members of Purchaser’s family, as required, (iii) pay all fees, points and charges required in connection with such application and loan, (iv) pursue such application with diligence,
and (v) cooperate in good faith with such Institutional Lender(s) to obtain a Commitment.Purchaser shall accept a Commitment meeting the terms set forth in subparagraph 8(a) and shall comply with all requirements of such Commitment (or any other commitment accepted by Purchaser).Purchaser shall furnish Seller with a copy of the Commitment promptly after receipt thereof.
* (Delete this subparagraph if inapplicable) Prompt submission by Purchaser of an application to a mortgage broker registered pursuant to Article 12-D of the New York Banking Law (“Mortgage Broker”) shall constitute full compliance with the terms and conditions set forth in subparagraph 8(b)(i), provided that such Mortgage Broker promptly submits such application to such Institutional Lender(s). Purchaser shall cooperate in good faith with such Mortgage Broker to obtain a Commitment from such Institutional Lender(s).
** If all Institutional Lenders to whom applications were made deny such applications in writing prior to the Commitment Date,Purchaser may cancel this contract by giving Notice thereof to Seller, with a copy of such denials, provided that Purchaser has complied with all its obligations under this paragraph 8.
* If no Commitment is issued by an Institutional Lender on or before the Commitment Date, then, unless Purchaser has accepted a written commitment from an Institutional Lender that does not conform to the terms set forth in subparagraph 8(a),
Purchaser may cancel this contract by giving Notice to Seller within 5 business days after the Commitment Date, provided that such Notice includes the name and address of the Institutional Lender(s) to whom application was made and that Purchaser has complied with all its obligations under this paragraph 8.
* If this contract is canceled by Purchaser pursuant to subparagraphs 8(d) or (e), neither party shall thereafter have any further rights against, or obligations or liabilities to, the other by reason of this contract, except that the Down Payment shall be promptly refunded to Purchaser and except as set forth in paragraph 27.
* If Purchaser fails to give timely Notice of cancellation or if Purchaser accepts a written commitment from an Institutional Lender that does not conform to the terms set forth in subparagraph 8(a), then Purchaser shall be deemed to have waived Purchaser’s right to cancel this contract and to receive a refund of the Downpayment by reason of the contingency contained in this paragraph 8.
** If Seller has not received a copy of a commitment from an Institutional Lender accepted by Purchaser by the Commitment Date, Seller may cancel this contract by giving Notice to Purchaser within 5 business days after the Commitment Date,
which cancellation shall become effective unless Purchaser delivers a copy of such commitment to Seller within 10 business days after the Commitment Date.After such cancellation neither party shall have any further rights against, or obligations or liabilities to,
the other by reason of this contract, except that the Down Payment shall be promptly refunded to Purchaser (provided Purchaser has complied with all its obligations under this paragraph 8) and except as set forth in paragraph 27.
** For purposes of this contract, the term “Institutional Lender” shall mean any bank, savings bank, private banker, trust company, savings and loan association, credit union or similar banking institution whether organized under the laws of this state, the United States
or any other state, foreign banking corporation licensed by the Superintendent of Banks of New York or regulated by the Comptroller of the Currency to transact business in New York State; insurance company duly organized or licensed to do business in New York State;
mortgage banker licensed pursuant to Article 12-D of the Banking Law; and any instrumentality created by the United States or any state with the power to make mortgage loans.
For purposes of subparagraph 8(a), Purchaser shall be deemed to have been given a fully executed copy of this contract on the third business day following the date of ordinary or regular mailing, postage prepaid.”
A Brief Explanation of the Terms Used in Mortgage Contingency Agreements
We cannot blame you if you simply skimmed the above-provided provision rather than reading it in detail. Legalese is difficult for many people to understand due to its relatively inaccessible verbiage.
Instead of leaving you wondering what all of that means, let us help define some of the key terms exemplified in the above mortgage contingency provision:
- The Contract Is Based on the Mortgage Contingency:
The first major piece of the mortgage contingency clause is a description of the mortgage contingency itself. As explained above, if the mortgage contingency is not satisfied and the buyer is unable to procure financing, then the rest of the mortgage contract is void.
This operative portion of the mortgage contingency provision simply voids the rest of the contract if the provision is not satisfied.
- The Lending Terms:
Another important component of a mortgage contingency clause is a specification of what would constitute sufficient financing to satisfy the mortgage contingency provision. Generally, mortgage contingency clauses will state a minimum dollar amount and interest rate that the lender must be willing to provide before the contingency is satisfied.
This term protects the buyer from being locked into the home purchase contract if the buyer is only able to obtain partial financing.
- The Contingency Expiration Deadline:
All mortgage contingencies have to have a set expiration date, or else the home seller could be left perpetually on the hook while the buyer searches for financing that may or may not materialize.
The typical mortgage contingency provision will expire somewhere between 30 and 60 days.
- A Deadline Extension Provision:
Some mortgage contingency provisions will also include a deadline extension provision. The purpose of a deadline extension term is to give the buyer an additional chance to obtain financing. Extension terms are not always included in mortgage contingency provisions, but are generally supplied where the buyer may need to pursue financing from multiple different sources.
- The Cancellation Clause:
The cancellation clause is closely related to the description of the mortgage contingency clause. The cancellation clause provides the buyer with a mechanism to cancel the remainder of the contract in the event the buyer’s attempts to seek financing are ultimately not fruitful.
The process of buying or selling a real estate property is always complicated and you need to hire an experienced attorney to fill out all necessary documents. Knowing what the mortgage contingency is and how it works is not enough to protect yourself from home sellers and real estate brokers who might not agree to a mortgage contingency clause.
Hiring an attorney to review your home purchase contract before you sign it is the best way to protect yourself and your family from agreeing to a bad deal.
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Law Office of Yuriy Moshes is a full service real estate law firm serving clients in New York and New Jersey. If you have any additional questions about mortgage contingencies, please reach out to us either by writing your questions in an email to email@example.com or by calling our office at (888) 445-0234. We provide free consultations to all homebuyers seeking the services of our attorneys.