Don't let the mortgage contingency clause blow up your home sale
Selling a home can be one of life’s most stressful experiences.
The uncertainty around this transaction is caused in part by the multiple contingencies contained in a standard real estate contract.
One of these is the mortgage contingency.
How does this contingency work, and how can sellers manage it effectively?
A contract contingency is something that must be fulfilled before a contract can be finalized. If a contingency is not fulfilled, then the contract is null and void.
A home loan contingency in a real estate contract gives the buyer the right to cancel the contract if an adequate mortgage cannot be secured.
This agreement says that the buyer will try to secure a particular type of loan (FHA, VA, conventional) at no more than a stated interest rate (prevailing market rate) for a particular percentage of the purchase price (typically 80%) by a specific date (some date prior to the closing).
The essence of this contingency is to protect the buyer, with the seller accepting all of the risk.
If the buyer is unable to find a mortgage that meets the requirements of the contract, the buyer is allowed to walk away with the earnest money.
The seller is protected in two ways.
First, if the buyer can’t find a home loan but fails to notify the seller in a timely manner, the buyer cannot walk away from the contract.
Another protection for the seller is that most contingencies give the seller the right to find a loan for the buyer, if the buyer is unable (or unwilling).
In addition to these protections, the seller can position himself or herself in other ways to assure that the buyer will not abuse the contingency:
- The stated interest rate in the contingency should be just higher than the current average cost of a home loan to help assure that the buyer will find an acceptable rate.
- The contingency should end at least a few weeks prior to the closing to avoid last-minute cancellations.
- The earnest money should be as much as possible to place some risk of loss on the buyer.
Although the contingency is designed to protect the buyer, sellers can position themselves to take some risk off the table.
Clint Costa is an attorney and CPA at the law firm of Shaheen, Novoselsky, Staat & Filipowski in Chicago.