At the beginning of 2021, I was drinking coffee from a distance with my friend Sarah, who had just bought a house. In between sips of my latte, she described everything she and her husband Han had done to make their offer as attractive as possible to the sellers. “We even withdrew our contingency funding. Maybe that’s what did it.” So what is contingency funding in a home offering? Why was the seller of Han and Sarah’s new house so excited that they had abandoned it? And when is it safe for you to exclude funding contingencies from your own proposal? Let’s explore.
What is contingency funding?
A financing contingency, also known as a loan contingency or a mortgage contingency, is a clause in your home offer that allows you to back out of a deal if you can’t secure your mortgage. He tells the seller:
Me when I can’t secure funding during closing | Source: Giphy.com
“I have been pre-approved for a mortgage, so I shouldn’t have any problems getting my mortgage and getting your money at closing time… But if I have any problems getting the financing approved, this clause allows me to back out of the deal without penalty and take my deposit with you.” Your deposit is the 1% to 3% you put into the home at the start of closing, also known as “good faith money.”
Financing versus contingency assessment
In short, your home offer may include several types of real estate contingency clauses that state: “If condition X is not met by the seller, the property, or even me as a potential buyer, I can withdraw my offer. makings.” Your contingency financing is just one of them – don’t confuse it with your appraisal contingency, which says, “If the home’s appraised value is below the agreed selling price, I can opt out and keep my deposit.”
What is included in the proposal’s funding contingency clause?
Careful contingency financing typically includes the following key points:
- Your type of mortgage – Regular, FHA, etc.
- Deadline – Usually within 30 or 60 days after the seller accepts your offer.
- Quantity – How much money will you need for a mortgage because you will have to back out of the deal if you get approved for less.
- Term – 15 years old, 30 years old, etc.
- Acceptable interest rate – Pretty clear.
If you choose to include contingency financing, you will need to spend time with your real estate agent to carefully tailor each term to your needs. Now, if you are serious about buying a home in today’s competitive market, getting a pre-approval letter is a must. Submitting a proposal without prior approval is technically still possible, but it’s like showing up on an Indy 500 on a Prius. The pre-approval letter is a note from the mortgage lender to the seller that says, “I’ve checked Chris’ finances and he’s ready to go. We are ready to lend him enough money to buy your house. This begs the question:
If I have already received pre-approval, why do I need contingency funding?
It is important to remember that pre-approval is not a promise. Even after pre-approval, “there are many unknowns in mortgage processing,” says Mark Milam, founder of Highland Mortgage. For example, your lender still needs to:
- Verify your self-employment/rental income.
- Order extracts from the IRS and study discrepancies carefully.
- Conduct fraud checks (i.e. undisclosed divorces, child support obligations, etc.).
And much more. Also, if you’re buying an apartment, your lender now has to check the building’s structural integrity before approving your mortgage, a rule laid out by Freddie Mac and Sally Mae after the Champlain Tower collapse. So there is still a lot of paperwork to be done between getting pre-approved and getting a mortgage. That’s why most homebuyers prefer to keep their financial reserves for the contingency—just in case there’s a disruption, they want to be able to bail out without losing their deposits.
Why aren’t sellers big fans of contingency financing?
Let’s put you in the position of a salesperson for a second. Now you choose between two offers:
- Sentence 1 says “I have money right here.”
- Sentence 2 says, “I must have the money by July.”
Which offer are you most likely to choose? By now, you probably understand that offer 1 comes from a fairly wealthy investor, while offer 2 could come from a young couple who are just trying to buy their first home. So you can accept suggestion 2 on principle. However, accepting an offer with windfall funding can be risky for sellers. Despite good intentions, the couple could run into trouble with the IRS, or interest rates could rise too high since they were proposed. Then, if they use their windfall funding to decline on the 30th day of closing, you as the seller will have to re-list your home for sale. This will not only increase its time in market (DOM) by 30 days; it will now be marked as “re-listed”. So, even if it’s not your fault, a buyer’s rejection can actually lower your home’s market value.
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That’s why sellers don’t like to finance contingencies: they let the buyer get away with impunity, leaving you to clean up the mess. On the other hand, sellers like to see offers with no financial contingencies (or no contingencies at all). Because an offer with no funding contingencies essentially means “If we can’t buy this house due to funding issues, you’ll keep our deposit (~$2,500-$10,000)”. Okay, now let’s put your customer’s shoes back on. You know the market is crazy, so you want your offer to look attractive to sellers. But at the same time, you don’t want to give up too many buyer protections and risk your makings. So…
When is it safe to forego funding contingencies in favor of a more competitive offer?
Eliminating contingencies means you are betting your down payment on getting approved for a mortgage. The problem most buyers have with this idea goes back to Mark’s earlier comment – that between pre-approval and final approval, there’s still a lot of paperwork to be done, and therefore a lot of little places where gremlins can hide (IRS issues, problems with check 1099, etc.). .). So, if there are a lot of paperwork between pre-approval and final approval, can your lender take care of that before you make an offer? Enter a glorious loan approval.
Get full “loan approval”
According to Mark, loan approval is when your lender goes beyond pre-approval and carefully reviews your assets, income, credit, and employment. They make 99% of the paperwork for final approval even before you submit an offer. This makes it safer for you to deal with funding contingencies and speeds up closing times, making your offer much more attractive to sellers. However, loan approval is risky for lenders; they require time and money that they may never recoup if the buyer never buys the house. This is why lenders usually only fully approve a loan for the most qualified clients they know to be serious. You can increase your chances of your lender fully approving a loan for you if you:
- Work with a small local lender (not a big, busy bank).
- Have excellent credit.
- Put 20% down.
- Build trust and rapport with your lender by filing on time, avoiding human error, etc.
As a next step, you can ask your real estate agent if they know of a good local lender who will consider a full loan approval for someone with your buyer profile.
essence
Financing contingency provides you, the buyer, with a back door out of the contract if your mortgage financing falls through. Without it, you can still opt out, but you’ll have to leave your deposits on the table and, in rare cases, risk being sued by the seller. Luckily, it’s also one of the safest real estate contingencies to take out of a home offer under the right circumstances. If you can get full loan approval from your lender, you can avoid financial contingencies, close faster, and generally dazzle sellers in a tough market. Featured image: Pravinrus/Shutterstock.com