Loan contingency removal can benefit both the buyer and seller in a real estate transaction. But there are some things you need to consider first.
A contingency sets conditions that the buyer or seller needs to meet to complete the sale contract. If you are the seller, this means you will have to wait 30 to 60 days before closing the deal. There is also a chance that the buyer ends up backing out.
Meanwhile, if you are the buyer, you might find your offer getting rejected because of the loan contingency. And you think that not including it in your offer might help you get the contract. But before you do anything about this, you must first understand what a contingency is.
In this article, you will learn everything you need to know about loan contingency, including:
- What a loan contingency is
- How a loan contingency impacts a buyer’s market vs. a seller’s market
- What it means to remove the loan contingency
- When it is okay to waive your loan contingency
- What the loan contingency process looks like
- Other contingencies you may include in the contract
What Is a Loan Contingency
A contingency is an action or condition that the buyer or seller must meet before completing the home sale. It also protects both of them from penalties in case the transaction falls through for certain reasons.
One of the contingencies you will encounter is a loan contingency. It is also called a contingency loan, mortgage contingency, or financing contingency. It specifies that if the buyer cannot secure financing within a set period, then the contract is void. The buyer gets their earnest money deposit back, and the seller can re-list their house and make a deal with a different buyer.
A loan contingency could also spell out the type of interest rate and fees that the buyer should get for them to buy the property. This helps the buyer back out of the sale if they could not find a mortgage with terms that they agree with.
This contingency might take effect when the buyer does not get approved for a mortgage. It also applies when the home appraisal ends up being below the asking price, as it often results in the mortgage lender disapproving the loan. Buyers should make sure to include a loan contingency if they are not yet sure that they will get full mortgage approval.
A loan contingency may be a downside for the buyer if they are not careful. They must pay close attention to what they have to do to meet the terms of the contract. Otherwise, they might have to buy the property even if they have been unable to secure financing.
Loan Contingency in a Buyer’s vs. Seller’s Market
Loan contingencies can impact the buyer and seller depending on the type of market they are in during the transaction.
If You Are in a Buyer’s Market
During this time, a loan contingency can protect the buyer in a real estate transaction. If the homeowner wants to sell their property in this market, they may have to allow for various contingencies to put the buyer at ease.
This gives the buyer more wiggle room to back out of the sale without penalty if they find problems with the home or have difficulty securing a loan. The buyer might also have the upper hand when negotiating closing costs.
If You Are in a Seller’s Market
In this type of market, the buyer has a little less leverage. Because a loan contingency requires the buyer and seller to agree on the time frame, the seller can request a shorter deadline. The buyer then has to fulfill the terms or have the contract voided, which frees up the seller to accept a better offer. The seller might have the option to choose an offer with fewer or no contingencies in place.
What Loan Contingency Removal Means
A loan contingency removal means that the buyer is on the hook for the contract terms whether they can get a loan. So if you failed to secure financing, you are still obligated to buy the property. Should you choose to cancel the contract, you will lose the deposit you have made on the home.
Removing the loan contingency does not mean that the buyer is paying with cash. They can still finance the home they are buying even if they waived this part of the contract.
Removing loan contingency can happen in one of two ways:
Active Loan Contingency
An active loan contingency gives the buyer control over when to remove this clause. For them to do this, the buyer must either satisfy the contract terms or notify the seller of their intent to apply loan contingency removal before the contract can move forward. Even if there is a deadline set, the contingency applies until it is lifted, and the buyer can still back out of the sale without facing penalties.
This type of contingency is not used in certain states, so check with your real estate agent on what contingencies are usually like in your area.
Passive Loan Contingency
Meanwhile, passive loan contingency removal automatically applies once the deadline passes. Here, the buyer must secure financing before the contingency expires on the set deadline. If they fail to tell the seller that they were not able to get a loan approval in time, they will still be bound to buy the property. Backing out of the sale will cause them to lose their deposit.
But if the buyer informs the seller that they got denied for a mortgage before the contingency expires, the seller could cancel the contract without penalty for either party. The buyer could also request an extension. But since the seller does not have to agree to it, the buyer could show that they are serious about their purchase by making an additional deposit in exchange for more time.
When to Remove Loan Contingency
Applying loan contingency removal will depend on the market and the buyer’s financial circumstances. If you are in a very competitive seller’s market, the buyer can waive their loan contingency to make their offer more appealing to the seller. Sellers often have to consider more than one bid on their property, so they are weighing the purchase price and other terms, which includes loan contingency.
But waiving the loan contingency is risky for the buyer because it puts their earnest money deposit at risk. As a buyer, consider doing this only if:
- You feel confident that you can get your mortgage;
- You have the cash to pay for the house in full; or,
- There is someone in your family who would be willing to provide financial support in case your loan application is denied.
Loan contingency removal is also part of the process once you have secured financing for the property. For example, a buyer in California would sign a contingency release form once they get approved for a mortgage. Loan contingency is usually the last one that the buyer waives before closing the deal.
How Loan Contingency Removal Works
Most of the time, and depending on the state where you are buying or selling a house, removing the loan contingency means that the buyer did not include it in their initial contract. If it is included, there would also be a date after which the contingency expires. Should the buyer fail to back out of the sale based on the contingency before the deadline, then the contract becomes binding.
If you are buying a house in California, you need to complete a form called Contingency Release Agreement for every contingency that you are removing from the contract. This allows the seller to keep your earnest money deposit if the transaction falls through.
Other Things Buyers Should Know About Loan Contingency
Here are some information and tips that many buyers want to know:
Loan Contingency Can Last Between 30 and 60 Days
Both the buyer and seller must agree on the timeframe in which the buyer needs to get mortgage approval. Usually, this period ranges from 30 to 60 days. If you are not able to get a loan within the agreed time, then the seller can cancel the contract and deal with another buyer. But if you were able to find a way to purchase the house, then you can enact the loan contingency removal and finalize the sale.
Be Careful With Your Finances While Securing Your Home Loan
It is best to know how long you have to secure financing, especially if the seller asks for a shorter timeline. While you are applying for a loan, do not make any big purchases, cancel your existing credit lines, or open new ones until you get approved. These financial activities can affect your credit score which can then affect your loan application.
Do This Instead of Waiving Your Loan Contingency
If you are in a seller’s market and want to outbid other offers, do not waive financing contingency. Instead, consider putting in a higher purchase price and/or a bigger down payment. Once the seller accepts your offer and enters a deal with you, you can then renegotiate your purchase price. The best time to do this is after you get the property inspected or appraised.
Other Real Estate Contingencies You May Encounter
Aside from loan contingency, here are some other conditions you could include in your home sale agreement:
Home Inspection Contingency
This requires the buyer to get a professional home inspection done within a certain timeline before completing the sale. This ensures that the buyer receives important information about the house they are buying and allows them to negotiate repairs and sale price or even to back out of the agreement. Contingencies that are similar to this include pool inspection and pest inspection.
Appraisal Contingency
This clause allows the buyer to back out of the contract if the appraisal value of the property is less than the agreed-upon purchase price. It usually ties in with the loan contingency since lenders require the home to be appraised before fully approving the loan. If the property turns out to have a lower value than the purchase price, then the lender might not approve the buyer’s application.
Radon Contingency
Radon is a radioactive, odorless, tasteless, invisible gas that can cause health issues and even death if you inhale it in large quantities. While it is found all over the country, homes in the Northeast, Midwest, Southern Appalachia, and the Northern Plains might have elevated levels of this gas. If you are buying a property in this area, it is common to include this contingency in the contract.
The Bottom Line
A loan contingency states that the property sale can occur once the buyer secures a mortgage to pay for their purchase. This helps the buyer make sure that they can afford the house they wish to buy. This also helps the seller by allowing them to back out of the sale without penalty if the buyer cannot get a loan, though they have to wait 30 to 60 days to be able to do this.
Loan contingency removal can help close the deal faster. But if the buyer waives this, they may not be able to back out of the contract without losing their earnest money deposit in case an issue appears. So instead of leaving this out of the agreement, consider pursuing other alternatives.
Contingencies are not the only things you need to think about when buying or selling a property, especially if you are an investor. Before you even think about buying or selling, you must first understand the market, define your strategy, and calculate your potential income. Mashvisor has been helping property investors like you to:
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