The financing contingency: protecting your deposit if the loan falls through

What it does

The CFPB explains that if you are borrowing money to buy a home, you likely have a contract with the seller that may limit the time and flexibility you have to close, and may subject you to legal action if you break it. It points buyers to the mortgage contingency clause, also called the financing or loan contingency clause, which tells you whether your deposit will be refunded if the sale is cancelled because you are unable to get a loan.

The CFPB also recommends making your offer contingent on obtaining financing when you are shopping for a home.

What a good clause spells out

Forms vary by state, but strong financing contingencies typically state:

• Loan type, such as conventional, FHA, VA or USDA.
• Loan amount or loan-to-value, so you are not forced to accept a smaller loan.
• Maximum interest rate or payment, so a big rate jump does not bind you.
• Deadline, the date by which you must get loan approval or give notice.
• Notice rules, how and to whom you must give notice if you cannot get the loan.

If the clause only says "subject to financing," the details may be decided by default terms in your state's form or by a dispute later.

Deadlines and approval

A preapproval is not a final approval. The CFPB says preapproval letters are not guaranteed loan offers. Your lender still has to underwrite you and appraise the home, and it may issue a conditional approval with items to clear. Set a deadline that allows for that, and ask your lender how long its approvals currently take.

If the deadline passes without notice from you, many contracts treat the contingency as satisfied or waived, even if your loan is not final yet. Mark the date and ask your agent about extensions early.

Appraisals and government loans

Appraisal shortfalls are often handled separately. Many contracts have a distinct appraisal contingency. FHA and VA add their own protections:

• FHA. HUD's handbook requires an amendatory clause if you sign the contract before receiving the FHA appraised value statement. It says you are not obligated to complete the purchase or lose earnest money unless the appraised value is at least a stated amount, though you may proceed anyway.
• VA. VA's escape clause says you will not forfeit earnest money or be obliged to buy if the price exceeds VA's reasonable value.

Neither replaces a financing contingency for other reasons a loan might fail, such as income or credit problems.

Waiving it

Waiving the financing contingency can make an offer more attractive, but it shifts the risk of a denied loan onto you. It may be reasonable if you have substantial cash and could close without the loan, or a fully underwritten approval. For most first-time buyers, keeping it is the safer choice.

Protecting your approval

Once you are under contract, avoid new credit, big purchases and job changes, and answer lender requests quickly. Changes after preapproval can derail an approval that looked certain.

The bottom line

A financing contingency protects your deposit if your loan falls through. Spell out the loan type, amount, rate and deadline, give written notice on time and avoid changes that could derail approval.