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Excellent question. I’m glad you asked!
The financing contingency is part of the purchase and sale agreement. It is a clause that states if the buyer is unable to secure financing (e.g., a mortgage), they can terminate the transaction, and their earnest money will be returned. It is part of the financing addendum (Form 22A in Washington). This is something that is of benefit for both the buyer and the seller. Here’s why:
- If the buyer cannot secure financing, they are not penalized for it. There are many reasons this could happen, which we’ll discuss shortly.
- The seller isn’t stuck waiting for the buyer to get their financing. If the deal won’t work, finding out quickly is better. This allows the seller to return the home to the market and find a new buyer.
How this works
First, the buyer’s agent will add the financing addendum to the purchase and sale agreement. In Washington State, there is a section called “financing contingency.” It might be called something different in your state. This section will explain how both parties agree to act in different circumstances. I’m going to future-proof this article by being more general than specific. Why? Because forms change, and I don’t want to lead anyone astray.
One of the parts could be a seller’s notice to perform. It states that the buyer will notify the seller that they have already started securing financing. In Washington State, this can take a couple of weeks, plus or minus. To simplify it, tell your mortgage lender to notify your real estate agent and the selling agent that the process has begun.
This should be automatic but hey, things happen.
This needs to happen. Should your agent not inform the sellers, they could cancel the contract. Why might they do this? What if they found out that there was another offer for $50,000 more right after you went mutual?
ALWAYS KEEP IN COMPLIANCE WITH THE CONTRACT – Jacob’s Rule #1
Another section will be an automatic waiver of financing contingency. Unless the buyer cancels the contract within an agreed-upon time, they will be on the hook. In other words, they will lose their earnest money if they cancel the contract.
Appraisal less than sales price is the biggie everyone focuses on. When you purchase a home with a mortgage, the lender (bank, credit union, mortgage lender) must have an appraisal done on the house. They will hire an appraiser to go to the house (the buyer usually pays for this). They will look at the house and check for a couple of things:
- Is this house safe? For example, do the stairs leading to the front door look like the deck of a thousand-year-old sunken pirate ship? If yes, they will call that out.
- Is the house worth the amount you are purchasing it for?
Let’s walk through that last part
You find your perfect home at the amazing price of $500,000. You get it under contract for that amount. However, the appraiser comes out and says the house is only worth $480,000. This means the bank will only loan you $480,000, not the $500,000 you agreed to with the seller. Several things can happen, and I’ll go through them so you have them in one place:
- Negotiate with the seller to drop the price to $480,000. ⬅️ What I would do first.
- Negotiate with the seller to reach a middle ground like $490,000.
- Trigger the appraisal less than sales price clause, cancel the contract, and get earnest money refunded.
- Dispute the appraisal – this sometimes happens:
- Get a copy of the Appraisal Report and review it.
- Look at what comparable properties (comps) were used.
- Provide updated comps if you find ones you think work better.
- Inform your lender that you are disputing the appraisal.
- Request a second appraisal.
With that last part, the buyer will have to pay for a second appraisal, and it is possible that the exact same appraiser will go to the property. I can’t say how it is in other states however in Washington, appraisers are cycled through. It is the luck of the draw. It keeps the banks from pulling shenanigans–which is a good thing.
Troubleshooting
Let’s say the lender has yet to secure financing, and the deadline is fast approaching. What then? The buyer’s agent should be in communication with the selling agent about where the deal is at. In this case, the buyer’s agent must talk to the lender, find out what is happening, and inform the selling agent. The intelligent thing to do is to fill out an extension and have both parties sign it. At this point, everyone wants the deal to go forward. Buyers, I wouldn’t be too concerned.
The house appraises for less than the sales price, and the seller will not budge. In this scenario, you will do anything to get this house and need help financially to make it work. Luckily, you have friends or family who can make it happen for you and love you enough to do it. They can gift you the money. Why do this instead of getting another loan? 👇
The loan underwriter will look at your debt to income ratio. It sets off alarm bells if they see you taking out loans while under contract. It can blow up the deal. Like in the following example. 👇
Uh-oh. You bought a Ferrari.
When you purchase a home, your mortgage lender should explicitly say, “DO NOT GET A LOAN ON ANYTHING ELSE, ESPECIALLY A CAR.” Do not rack up ANY debt during this period. It could blow up financing and often does. If the underwriter sees that you have been creating new debt while trying to buy a home, it sends a message. That message is that you might be unable to fulfill the loan obligation. Underwriters get spooked like horses. Please do EVERYTHING you can to KEEP THEM HAPPY.
That is pretty much it.
In Conclusion
The financing contingency is a small but important step in the home-buying process. I think you should have a competent real estate agent on your team. If you’d like to interview me or have any questions please reach out.
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