Mortgage contingency: What it is, how it works

With single-family homes in the U.S. selling for a median price of $359,000 in January 2023, according to the National Association of Realtors, it’s no surprise that most people need to borrow money to finance a home purchase.

The tricky thing is, the homebuying process usually involves making an offer before you actually get final approval for your home loan. What happens if a seller accepts your offer but your lender does not approve your mortgage application? That’s where a mortgage contingency comes into play.

What is a mortgage contingency?

In a real estate transaction, both sides can add contingencies to the purchase and sale agreement. These are clauses that let either side back out of a deal or renegotiate the terms of the transaction if certain criteria are not met.

“A mortgage contingency allows the buyer the ability to cancel the transaction if they are not able to get the final approval for their mortgage,” says Christopher Avallon, owner/broker with the Princeton, New Jersey–based Avallon Real Estate Group.

Think of it like a safety net: A mortgage contingency prevents potential buyers from getting into a situation where they’re committed to buying a home with money they simply do not have.

How mortgage contingencies work

The details of a real estate transaction are all laid out in the purchase and sale agreement, or PSA. The PSA describes the property, the purchase price and the timeline that the transaction will follow.

It also includes all of the contingencies and the deadlines by which they must be met. For a mortgage contingency, the contract may specify that the buyer must make a diligent effort to secure financing by a specific date prior to prior to closing.

“This protects buyers by offering them a legal way out of the contract, which allows them to get their deposit back due to the fact that their mortgage was not approved,” Avallon says.

A typical mortgage contingency specifies both the amount that the buyer must be approved to borrow and the date by which they must receive approval. It will also specify that that borrower must make reasonable efforts to get a loan — meaning you can’t get wriggle out of a deal by intentionally getting denied for a mortgage. The buyer typically has up to four weeks to secure the loan before this contingency comes into play.

If a buyer does back out of a deal because their mortgage loan was not approved, mortgage contingencies will usually allow them recover their earnest money deposit. It’s common to put down some amount of earnest money when you sign the PSA to show your commitment to purchasing the home. Backing out without good reason, though, usually means forfeiting that deposit.

Can you waive a mortgage contingency?

You can waive any contingency in a real estate transaction, including a mortgage contingency. However, that doesn’t mean it’s a good idea. Your mortgage contingency gives you a way out the purchase if you can’t qualify for a mortgage. Waiving it puts you at risk.

Imagine you make an offer to buy a home. You provide $10,000 in earnest money and apply for a mortgage loan to finance the purchase, but you waive the mortgage contingency. If you are not approved for that loan, you wind up with two options: either find some other way to pay for the home, possibly with an all-cash offer, or back out of the deal and lose your $10,000. Neither is particularly appealing.

If that’s the case, why would anyone ever waive a mortgage contingency? Well, if you aren’t financing the purchase with a mortgage, then you don’t need it. But the main reason someone might waive the financing contingency is to make their offer more competitive in an incredibly strong seller’s market. However, given the risk, it’s probably smart to avoid doing so unless absolutely necessary.

Other common real estate contingencies

Contingencies are common in real estate transactions, and they can cover far more than just financing. Some other common ones include:

• Home inspection contingency: Many buyers waived the inspection contingency during the height of the pandemic, when bidding wars were commonplace and they were desperate to make their offer stand out. But it’s risky: If the house proves to have major problems, you could be stuck with huge repair bills.
• Appraisal contingency: Lenders typically require a home appraisal before approving a loan, to ensure that the home is worth enough to secure the mortgage. Appraisal contingencies allow the buyer to back out if the home is appraised for less than they were expecting.
• Homeowners insurance contingency: Lenders will also usually require that the home be properly insured. This contingency requires that the buyer must be able to get insurance for the property.
• Title contingency: This ensures that the property being sold has a clear title, with no liens or claims against it.

Bottom line

Given how many people rely on borrowed money to buy homes, mortgage contingencies are common. They’re an important safeguard for buyers who can’t afford to lose their earnest money or pay for a home in cash. Assuming you’ve gotten preapproved for a mortgage, requesting one likely won’t do much to weaken your offer, so it’s worth putting the contingency into your offers.