Drama queen: The mortgage contingency clause

All real estate contracts, except for cash deals, have a mortgage contingency. The mortgage contingency is the drama queen of the real estate contract. It brings out the worst in both seller and buyer and it confuses and frustrates everyone.

A mortgage contingency is a condition in the contract on the buyer  being approved for financing by a certain time at a certain interest rate. The contract usually says: “This contract is contingent on the Buyer getting an 80% mortgage for 6 per cent by December 31.” If the buyer is not approved, by December 31, the buyer’s attorney sends a request to extend the mortgage contingency. If the buyer does not obtain financing or if the seller does not grant the extension, the buyer can declare the contract to be dead and all earnest money will be refunded to the Buyer.

Most real estate deals have about 3 mortgage extension requests. Some out-of-control contracts have up to 20 extension requests. I call these deals, “draggers.”  A dragger is not fun for anyone. The worst situation in the world for seller and buyer is to have a real estate deal evolve into a dragger with 10 mortgage contingency extensions, only to have the buyer denied for financing at the last minute. Not fun.

Mortgage Contingency from Buyer’s perspective: All buyers think that they are approved for financing about 5 seconds after they sign the real estate contract, but the truth is that it takes about 30 days for a full, unconditional approval. Mortgage brokers often tell clients “You’re approved,” when they pre-qualify the buyer and this starts the confusion. Of course, what the mortgage broker means is that Mr. Buyer appears to have the credit score and income that he might qualify for financing.

A full mortgage approval requires: An appraisal of the property, verification of all of the buyer’s accounts, a credit check, submission of the loan to underwriting and the clearing of all conditions. When a loan comes out of underwriting, there are always many conditions on the loan approval. Typically, mortgage contingency extensions are requested until all of the conditions are cleared. The holy grail of mortgage approval is the “clear to close.”  Extensions are no longer needed once the loan is clear to close, which means that all conditions have been cleared.

Buyers don’t like mortgage contingency extensions because a mortgage contingency extension request implies that:  a. The closing will be delayed. b. The extension request casts an aura that the buyer is some kind of slacker who can’t get a mortgage.

However, the buyer really won’t like it when he or she is denied financing and then can’t get their earnest money back because the mortgage contingency expired.

From Seller’s perspective: The seller signs a contract and then gets roughed up by the buyer on the inspection. Mr. Seller bites the bullet and gives a $2k credit on the inspection, but then has to put up with 4 mortgage contingency extension requests from the buyer. With each extension request, the seller gets more frustrated because he feels he is stuck with an inferior buyer that will not qualify for financing.

Sellers often believe that the buyer’s earnest money is the sellers  (to keep) if the closing does not happen on time. Not really. The buyer’s earnest money will be returned, not given to the seller, if the contract is terminated while the mortgage contingency is still in force.

The best way to handle a mortgage contingency is to give at least 30 days to obtain financing. Too many contracts allow for only 10 to 14 days for the buyer to get financing and that means that there will be several mortgage extension requests. Other than allowing 30 days initially for the buyer’s financing, the parties just have to sit tight and realize that most closings will occur, some will close late, and there will always be two or three mortgage contingency extensions making both parties upset.

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