What is a Financing Contingency and How Does It Work?

A financing contingency is a clause that is commonly included in a purchase contract when buying a home. It allows the buyer time to secure financing for the purchase, and provides a safeguard in case the buyer is unable to obtain a loan. This contingency gives the buyer the option to terminate the contract and receive a refund of their earnest money if financing falls through.

How Does a Financing Contingency Work?

When a buyer includes a financing contingency in a purchase contract, it sets certain conditions that need to be met within a specified timeframe. These conditions typically include:

• Obtaining a loan commitment from a lender
• Securing a satisfactory interest rate
• Completing the loan application process
• Providing all required financial documentation

If the buyer is unable to meet these conditions within the specified timeframe, the financing contingency allows them to terminate the contract without any financial penalty. The buyer can then receive a refund of their earnest money.

Types of Financing Contingencies

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

Active Contingency

An active financing contingency requires the buyer to actively seek financing and provide regular updates to the seller on their progress. This type of contingency puts the responsibility on the buyer to actively pursue financing and meet the specified conditions within the agreed-upon timeframe.

Passive Contingency

A passive financing contingency, on the other hand, allows the buyer to rely on the seller's representation that the property is financeable. The buyer does not have to actively seek financing or provide regular updates to the seller. However, if the buyer is unable to obtain financing, they can still terminate the contract and receive a refund of their earnest money.

Benefits of a Financing Contingency

A financing contingency provides several benefits for both buyers and sellers:

• Protection for Buyers: A financing contingency protects buyers from losing their earnest money if they are unable to secure financing. It gives them the opportunity to back out of the contract if financing falls through.
• Peace of Mind for Sellers: Sellers can have peace of mind knowing that the buyer has a financing contingency in place. This contingency ensures that the buyer has the means to complete the purchase, reducing the risk of the deal falling through.
• Time to Secure Financing: A financing contingency allows buyers the necessary time to secure financing. It provides them with a specified timeframe to complete the loan application process and meet the conditions set forth in the contingency.

Should You Waive a Financing Contingency?

Waiving a financing contingency means that the buyer is willing to proceed with the purchase even if they are unable to obtain financing. This is a significant risk for the buyer, as they may lose their earnest money if they are unable to secure a loan.

Waiving a financing contingency may be considered in competitive real estate markets where sellers prioritize offers without contingencies. However, it is crucial for buyers to carefully assess their financial situation and consult with their agent and lender before deciding to waive a financing contingency.

The Bottom Line

A financing contingency is an essential clause in a purchase contract that protects both buyers and sellers. It allows buyers the necessary time to secure financing and provides them with an option to terminate the contract and receive a refund of their earnest money if financing falls through. Sellers can have peace of mind knowing that the buyer has a financing contingency in place, reducing the risk of the deal falling through. However, buyers should carefully consider their financial situation and consult with professionals before deciding to waive a financing contingency.