Understanding the Financing Contingency Clause in Home Purchase Contracts

When buying a home, one of the most important aspects to consider is financing. Unless you're purchasing the property with cash, you'll likely need to secure a mortgage to complete the transaction. However, what happens if you're unable to obtain financing? This is where a financing contingency clause comes into play.

What is a Financing Contingency?

A financing contingency is a clause in a home purchase contract that allows the buyer time to obtain financing for the property. It provides a safety net for the buyer, allowing them to back out of the contract if they're unable to secure a loan. Similarly, the seller can also terminate the contract if the buyer fails to obtain financing within the specified period.

The financing contingency clause typically outlines the specific terms and conditions under which the buyer can terminate the contract. It may specify the maximum interest rate the buyer is willing to accept, the minimum loan amount they require, or any other conditions that need to be met for the financing to be considered satisfactory.

How Does a Financing Contingency Work?

When a buyer includes a financing contingency in their offer, they typically have a certain number of days to secure financing. During this period, the buyer will work with a lender to complete the necessary paperwork and gather all the required documentation. If the buyer is unable to obtain financing within the specified timeframe, they can inform the seller and back out of the contract without any penalties.

It's important to note that the financing contingency is a protective measure for both buyers and sellers. For buyers, it ensures that they're not obligated to purchase a property they can't afford. For sellers, it provides a guarantee that the buyer has the means to complete the transaction.

Types of Financing Contingencies - Active vs. Passive

There are two main types of financing contingencies: active and passive.

Active Contingency

An active contingency requires the buyer to actively seek and secure financing within the specified timeframe. They must submit loan applications, provide all the necessary documentation, and work closely with their lender throughout the process. If the buyer fails to meet these requirements, the contract can be terminated.

Passive Contingency

A passive contingency, on the other hand, does not require the buyer to take active steps to secure financing. Instead, it provides an automatic termination of the contract if the buyer is unable to obtain financing within the specified period. This type of contingency is less common and may not be as favorable for buyers.

How & When to Use Financing Contingencies

Financing contingencies should be used when there's uncertainty about the buyer's ability to secure financing. This can be due to factors such as low credit scores, insufficient income, or unstable employment history. By including a financing contingency in the contract, the buyer can protect themselves from potential financial risks.

It's important to carefully consider the duration of the financing contingency period. The buyer should ensure that they have enough time to secure financing without unnecessarily prolonging the transaction. On the other hand, the seller may want to limit the duration to avoid delays in the sale process.

Why Would You Not Have a Financing Contingency?

While financing contingencies provide protection for buyers, there are situations where it may not be in the buyer's best interest to include one. For example, in a highly competitive real estate market where multiple offers are common, sellers may prioritize offers without financing contingencies. In such cases, buyers may choose to waive the contingency to make their offer more attractive.

Consult With Your Agent and Lender

When it comes to including a financing contingency in a home purchase contract, it's always best to consult with your real estate agent and lender. They can provide valuable insights and guidance based on your specific situation. They will also help you understand the potential risks and benefits associated with including or waiving a financing contingency.

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