Mortgage Contingency Clause — Why is it important?

Almost every real estate contract that comes across my desk includes a mortgage contingency clause. My clients always have tons of mortgage-related questions for me, many of which I am not qualified to answer since I am not a mortgage broker or in the lending business. But when I represent a buyer during a real estate transaction, I always explain the legal ramifications of the mortgage contingency to him. Moreover, I have to protect my client’s interests with respect to their loan, and it helps if they understand why.

The mortgage contingency period (also known as the mortgage commitment period or the mortgage approval period) is extremely important to the buyer. Just like the attorney approval and inspection periods, a mortgage contingency period is just that — a contingency. The contract is contingent on the buyer obtaining a loan, typically within three to five weeks after the contract is executed (although the term could be shorter or longer). Most form real estate contracts include some language protecting the buyer’s ability to obtain financing. Developers’ contracts, on the other hand, tend to have more limited mortgage commitment language that favors the builder.

A buyer or his attorney need to look for the following points to make sure the buyer is protected — a) There must be enough time to obtain a loan commitment; b) The buyer should specify the maximum interest rate he is willing to pay; c) The buyer should clarify whether or not he is willing to pay points to obtain a more favorable interest rate; and d) The contingency should specify that the Buyer needs to obtain a FIRM mortgage commitment, not just any mortgage commitment. A commitment which is not firm includes conditions that must be satisifed prior to final loan approval. In today’s lending market, a commitment pretty much means nothing until there are no outstanding conditions.

On the date that the buyer’s mortgage contingency expires, one of the following three things should happen: 1) The buyer has a firm mortgage commitment that he is satisfied with in his hands; 2) The buyer’s attorney asks for an extension of the mortgage contingency period because the buyer’s loan is still being processed; or 3) The lender has denied the buyer’s loan, in which case the buyer’s attorney sends a copy of the rejection letter along with a request to cancel the contract and return the buyer’s earnest money. If the buyer doesn’t have a firm mortgage commitment and fails to notify the seller as stated above, he is bound to purchase the property. There have been many instances where a buyer failed to request an extension and was later unable to obtain financing. In such situations, buyers typically lose their earnest money. Technically, buyers can also be sued for specific performance, i.e. to complete the transaction. But the reality is that most sellers understand the buyer doesn’t have the money to complete the purchase, which is why such litigation is uncommon.

Buyers should actively follow up with their lenders throughout the transaction. In fact, for a smooth closing, all parties to the transaction should communicate regularly!