What Is a Loan Contingency?

Contracts for purchasing a home commonly include a loan contingency clause. The clause specifies certain requirements and conditions that must be met for the buyer to proceed with the sale. Contingencies allow you to walk away from an agreement without penalty. If you put down an earnest deposit when you submit your offer, the contingency clause can entitle you to a full refund upon contract cancellation.

How Contingencies Work

Mortgage approval is based on many factors. The purchase offer you submit on a home becomes a legally binding contract, if accepted. If you back out, the seller can charge you with a breach of contract. Any contingencies in the contract, however, cover you and protect your deposit if something goes wrong with the deal. Contingencies written into a contract must specify how a contingency will be satisfied or released.

Loan Contingencies

The standard loan contingency is one that states that you, as the buyer, are not bound to the contract if you fail to obtain approval for financing by a certain date. When you are pre-approved for a mortgage, the lender has qualified you for the loan based on your credit report, debt-to-income ratio and analysis of your financial situation. Major changes to your credit, debt, or assets after pre-approval can jeopardize your chances of getting the mortgage. The house must also meet certain requirements before the mortgage loan is approved. Lenders require a satisfactory search of the title record and an acceptable appraisal of the property before extending a loan. If you try in earnest but the conditions are not satisfied, the deposit is usually refunded and the house goes back on the market.

Passive Removal

A passive contingency removal requires a buyer to invoke the clause within a certain period of time to terminate the contract. If the deadline comes and goes and you have not canceled the agreement, the contingency is automatically removed -- and without the contingency, you are bound to the purchase agreement. For example, a passive contingency may state you will notify the seller if you have not obtained financing 25 days before the scheduled closing date. If you cannot gain approval and fail to let the seller know in time, you can no longer cancel the sale without penalty. Although you cannot be forced to buy the home if you have no financing, you will typically forfeit your earnest money deposit. When the passive removal method is used, silence means acceptance.

Active Removal

Active contingencies remain in force until removed. If an active contingency deadline passes, and the buyer has not released the contingency, it stays in place. For example, if a contact gives the buyer 17 days to remove an appraisal contingency, the contingency stays active even after day 17 has passed. Although the seller can require the buyer to respond as to whether he's obtained financing, the seller is unable to force the buyer to close escrow or keep the deposit. Although the active method of contingency removal requires more paperwork, it helps provide clarity and ensures buyer protection.

About the Author

Jeannine Mancini, a Florida native, has been writing business and personal finance articles since 2003. Her articles have been published in the Florida Today and Orlando Sentinel. She earned a Bachelor of Science in Interdisciplinary Studies from the University of Central Florida.

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