How a financing contingency clause works — and why you need one

When you put an offer on a home, you’ll generally sign a contract with the seller and put 1% to 5% of the home’s cost into an escrow account to show that you’re interested. But a poorly-written contract could lead to you losing that money, or more, if you don’t get approved for a mortgage.

What is a financing contingency clause?

A financing contingency clause is a line in the contract that’s drawn up when you put a bid on a house. This clause makes the purchase conditional upon receiving financing — usually a home loan. It also tells you how to proceed with the seller if you aren’t approved for the loan you expected.

It protects the buyer by making sure they can get out of the contract and back out of a sale if they aren’t approved for a home loan.

Do I need a contingency clause?

Yes. A financing contingency clause serves to protect you if you can’t get the financing you need for a potential sale. It’s crucial that this clause is in your contract unless you’re 100% sure your mortgage is in order.

This clause is especially important if there’s any doubt about a property’s value. Once you’ve signed a contract to buy a property, your lender determines how much your potential property is worth. If the value comes in lower than expected, your lender could decide not to extend you credit, or offer you a lower loan amount.

Without a financing contingency clause, you’d need to either come up with enough money for the home or back out of the contract and lose your deposit.

Do I need one even if I have preapproval from my mortgage lender?

Yes. While it’s a good idea to get preapproved before you start home shopping, it isn’t an ironclad guarantee.

Getting preapproved for a mortgage just means that your bank decided it’ll likely approve your loan. It isn’t a guarantee, and any number of hurdles can come up between preapproval and unconditional approval.

What should I look out for?

While financing contingency clauses are important, not all are created equal. While one clause could protect you and any money you put into an escrow account in earnest, another could end up being used as a weapon to pursue you for damages should your purchase not go through.

Pay attention to the following:

• Wording. A financing contingency clause states that you as the purchaser will take all reasonable steps to get the financing you need. If you don’t pay attention to the wording, those “reasonable steps” could put you in an unreasonable position.
• Specificity. The clause shouldn’t just make a general statement about obtaining finance — it should require finance with satisfactory terms. If you’re preapproved and counting on a specific mortgage deal, it could even specify the terms, bank and interest rates you need to secure. This protects you in the event your preferred lender doesn’t approve your home loan. Without a well-written clause, you could be forced to lose your deposit or take a loan from any willing lender — even if they have bad reviews and high interest rates.
• Expiration date. You should also pay attention to when the clause expires. There’s likely a specified date you need your loan by. If you don’t meet the deadline, the seller can choose another buyer.

What happens if I can’t find financing?

If you can’t find financing that meets the terms of the agreement before the expiration date, the contract is terminated and the seller can sell the house to another buyer.

You’ll generally get back any money that you put into an escrow account. But it’s a good idea to check the contract to make sure you’re not forfeiting the right to your escrow money.

How do I know if a financing contingency clause protects me?

It’s crucial to seek legal advice when buying a property. Have a lawyer examine the contract to ensure it provides the protection you need. While a lawyer can add to the cost of purchasing a home, they could potentially save you a lot of money in the long run.

A good lawyer can carefully evaluate the contract to make sure that the financing contingency clause, as well as the rest of the contract, won’t leave you in a financially unstable position or force you to buy a home that you don’t want or can’t afford.

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Bottom line

Adding a financing contingency clause when you put an offer on a house helps to keep you financially secure. But don’t just trust that the seller has your best interests at heart — hire a lawyer to review the contract with you. And once it’s signed, compare mortgage lenders to help you get financing before the contract expires.

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