When selling his house, a homeowner relies on a buyer to purchase his home in a timely manner. One of the most important contract provisions a seller can include and enforce in the sales contract is a financing contingency, which states that the buyer promises to buy the house if he can obtain financing. Although it protects the buyer, this clause also protects the seller by allowing him to get out of the contract if the buyer fails to get a loan.
Counting on the Contingency
When a buyer depends on mortgage financing to purchase a home, he must stipulate this in the purchase contract. A loan or financing contingency alerts the seller that the buyer has yet to secure a mortgage commitment from a lender. The clause also has a time limit for obtaining financing, although it's possible for a buyer to state that he has the full contract period to get a loan. For example, in California, a buyer typically has up to 17 days to gain loan approval or the seller can cancel the contract; however, if the buyer states a longer period in writing -- say 30 days -- the seller must wait until 30 days elapses before cancelling.
Not a Long-Term Commitment
A seller isn't committed to a buyer for the long-haul, that is, the proposed closing date stated on the contract. A seller commits to one buyer for a specified time period -- the loan contingency period -- after which he may cancel if the buyer fails to get a loan or change contract terms to keep the deal alive. Because he can't accept any other offers, with the exception of back-up offers, during this commitment period, he may lose out on more willing and able buyers. To offset this risk, a seller and his agent usually keep close track of the loan contingency period and ask the buyer to waive the financing contingency immediately upon its expiration.
Proper Proof Protects Seller Interests
The purchase contract may outline what the seller will accept as proof of buyer financing. For example, in Florida, a written financing commitment letter, or approval letter, from the buyer's lender may suffice. A seller can, however, impose more stringent requirements to further protect his interests. For example, he may require that the buyer also remove the financing contingency, eliminating the buyer's right to back out of the deal and reclaim his deposit if the loan falls through. This action is often referred to as an active contingency removal, release or waiver. It entails that the buyer sign and deliver a document to the seller eliminating the financing contingency.
Seller Claim on Buyer's Deposit
The seller may claim all or a portion of the buyer's initial deposit, which is typically about 1 percent of the sale price, if the buyer backs out after the financing contingency periods ends. If the buyer fails to gain financing within the specified time frame and is otherwise unable to buy the home, he is in breach of contract. The seller may cancel and obtain monetary damages as a result. The seller's ability to get any of the buyer's money as compensation for the buyer's breach usually depends on whether the seller enforced an active contingency removal requirement.
Karina C. Hernandez is a real estate agent in San Diego. She has covered housing and personal finance topics for multiple internet channels over the past 10 years. Karina has a B.A. in English from UCLA and has written for eHow, sfGate, the nest, Quicken, TurboTax, RE/Max, Zacks and Opposing Views.