What Is a Loan Contingency?

What Is a Loan Contingency?
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Proper home purchasing contracts have a contingency clause or conditions that must be met before the parties close the deal. A loan contingency protects the house buyer from unintended financial and legal repercussions arising from an inability to get financing. Since there is no standard loan contingency clause, use a lawyer to negotiate terms and provisions with the seller for you.

How a Financing Contingency Works

A contingency offer means you have placed an offer on a home, and the seller has accepted it, but you will only close the deal when certain criteria are met. Under the loan contingency, the seller allows you a specified time to get a loan to cover the purchase. If you do not get a lender to commit by the set date, you walk away from the sale without penalties, and you get your down payment back.

Active Removal of a Contingency Clause

Contingency removal varies from one contract to another. Active removal – which requires more paperwork – can, in theory, ensure a buyer’s protection beyond the contingency deadline. Under active removal, the buyer actually must ask in writing for the contingency to be removed. For example, if the clause allows the customer ten days to remove a loan contingency, it protects the buyer until he asks for it to be removed, even if it is beyond the ten-day period. The seller cannot unilaterally act and remove the contingency, but he does have the right to ask the buyer to communicate about the status of the loan application.

Passive Loan Contingency Removal

Passive removal is like an alarm clock – it goes off at the stated time, even if the buyer needs more time. For example, if the contingency states that a buyer will notify the seller of failure to obtain a loan 20 days before the closing date, by default the contingency expires if the buyer does not communicate in time. In this case, the buyer is bound by the agreement and cannot cancel the purchase offer without a penalty. The results, depending on your purchase agreement, can be serious problems such as forfeiting your deposit or facing lawsuits to compensate the seller for the time he took his house off the market.

Other Important Considerations

Include all of your contingencies as part of the purchase offer and ensure the seller agrees to the terms before signing the agreement. Removing your loan contingency makes your offer more attractive because it signifies your commitment to buy a house, but it is a potentially perilous decision. Consider all possible outcomes such as delayed funds or losing your job before waiving the contingency.