When you’re negotiating a purchase contract for your new home, a financing contingency is an extremely common clause to add to a contract. Ideally, sellers want to see that you’re pre-approved for financing and believe that you’ll have no trouble obtaining the financing. The more you can show the seller to support this belief, the more likely the seller will be to accept your offer and agree to favorable terms. But you must also protect yourself with a financing contingency. Even the best laid plans can go astray, and you could have financing all but guaranteed only to lose it at the last minute.
What is the Financing Contingency?
Basically, the financing contingency states that you agree to buy a property IF you can get financing. If you don’t include a contingency like this in your purchase contract, the seller could hold you to a purchase and sale contract and sue you for the amount of the purchase, or reasonable penalties for breach of contract. At the very least, you’d be likely to lose your earnest money, but you could also face additional penalties.
With a financing contingency in place, you have a legal loophole to back out of the deal. If you’re unable to obtain financing, by the specified date, you may be able to negotiate an extension, or the contract may become null and void. If this happens, the seller ceases to be under obligation to sell the home to you.
Make Sure you Define the Financing Contingency
It’s not uncommon to use generic wording for a financing contingency. Make sure that both you and the seller are in agreement on what the wording means. Define the terms of the financing contingency in writing. Instead of saying something like “buyer to obtain a mortgage on terms generally prevailing,” write out the terms that you’re willing to except, such as loan to value ratio, maximum interest rate and maximum fees and points.
For “buyer shall in good faith diligently pursue a mortgage commitment,” instead define how many mortgages you must apply – and be rejected for – before the financing contingency kicks in. Three lenders? 10 lenders? 30 lenders? Be clear what your commitment includes to avoid disputes with the seller and get the best protection from your financing contingency.