Typical homebuyers rely on a mortgage from a bank or lender to finance the purchase of a property. The challenge, in many cases, is that banks can't move forward in completing a loan application and approval without details on the purchase agreement. Therefore, real estate contracts commonly include a "mortgage contingency clause" that makes an agreed-upon purchase null and void if the borrower can't get funding.
A contingency is essentially a caveat to an accepted real estate agreement. In some cases, a buyer makes an offer on a house that simply states the price he is willing to pay. Often, though, contracts are written with one or more contingencies. Those who want to buy a home without having sold their existing one often include a contingency that they must sell their existing home within a certain period of time to complete the purchase. The most common contingency is the mortgage clause, because homebuyers typically need a bank loan to complete the purchase of a house.
When a buyer makes an offer, he normally submits it with a deposit that is commonly called earnest money. The specific amounts vary, but earnest money is a means of showing that a buyer is serious in his offer. If a seller accepts a contract with a mortgage contingency and the buyer is unable to secure financing per the contract terms, he is entitled to a refund of the earnest money. However, if the buyer backs out of a purchase before closing, the seller may normally either retain the earnest money or sue for damages for a breach of contract.
Confusion is common about the exact nature of a contingency clause. The typical contingency clause is actually based on the buyer's ability to gain loan commitment within a short period of time, often three-to-five days. A written mortgage commitment means a bank has formally agreed to provide financing for your home purchase. However, some buyers mistakenly believe the contract is contingent on their ability to actually receive funding. In fact, if you get a loan commitment but then fail to follow through with the loan process or show up with funds to cover closing costs, the contingency doesn't apply.
The mortgage contingency is often linked to another common contingency known as an appraisal clause or contingency. This means the buyer is able to nullify a contract if a loan appraisal falls short of the purchase price. Lenders typically require and coordinate appraisals because they want to ensure the value of a property before issuing a loan. Thus, if an appraisal falls short of the purchase agreement, the lender likely won't agree to the deal, and the appraisal allows the buyer to void the agreement.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.