Loan Contingency 101: A Guide for Sellers
A loan contingency, also commonly known as a mortgage contingency is one of the standard contingencies in an offer to purchase real estate. Wondering what a loan contingency is and how it impacts your home sale? Read on to find out.
History of Loan Contingencies:
Prior to the mortgage crisis, a loan contingency language typically stated that the offer was contingent upon the buyer obtaining a loan within a relatively short timeframe, such as 15 to 17 days after an offer is accepted by a seller.
During this time period, the buyer would:
- Submit all their documents to their lender.
- Have an appraisal done.
- Confirm that they could get a loan.
If the buyer failed to secure financing before the contingency date expired, they were allowed to back out of their contract and didn't lose any of their earnest money deposit.
However, if the buyer was confident that the loan could be obtained so they removed the loan contingency, then failed to get a loan - their earnest money deposit could be subject to forfeiture.
The New Normal for Loan Contingencies:
Since the mortgage crisis, buyers have modified the mortgage contingency. Sometimes they ask that it survives until the moment the bank funds the loan. In a worst-case scenario, a seller can be at day 60 in a 60-day escrow, learn the underwriter rejected the loan and have to start marketing their home all over again. Even in this case, the seller is most likely not going to be able to keep the buyer's earnest money deposit since the loan contingency stands until the loan is actually funded.
Sellers reading this post may cry, “Unfair!” Consider, though, buyers want this protection for a valid reason. Obtaining loans in today's environment is tricky. Buyers fear the bank pulling the rug out from underneath them at some point in the process. Because of this, it's common for a buyer to ask for the contingency to extend through funding and it's common for sellers to accept such offers.
How Sellers Should Protect Themselves:
Require that your buyers get preapproved prior to submitting an offer and ask hard questions before you accept the offer.
Here are a few good ones:
- Why aren't you absolutely confident in your ability to get a loan?
- What's your credit score?
- Can you send me a copy of your credit report reflecting that score?
- Do you fall into the category of well-qualified buyers, i.e., putting down at least 20% of the purchase price in cash?
- Can you show me a bank statement that reflects that amount in cash?
- Have you been preapproved or only prequalified?
- If not, why haven't you been preapproved?
If your buyer has a low credit score and doesn't have liquid cash to fund 20% of the purchase price, consider passing on the offer in favor of another offer. You can also counter and ask to shorten the contingency. If your buyer is taking out a VA loan or other loan that allows for a low or no down payment, just make sure they have enough cash to cover closing costs.
Have questions about mortgage contingencies? Ask us.
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