What is a mortgage contingency clause?

Real estate is a big investment. In fact, for many people, purchasing a house is the biggest financial transaction they're ever going to make. Therefore, it pays to be cautious. That's where a mortgage contingency clause can come in handy.

A contingency is generally any event that has to happen prior to an agreement becoming final. In real estate agreements, mortgage contingencies are common. In essence, they're a clause that says, "I will buy this property as soon as I get the mortgage approved by a bank."

Here's where the conflicts can come in. Some mortgage contingency clauses are fairly short. They might give the buyer anywhere from 30 days to a couple of months to get a loan to cover the purchase. Other clauses may be a lot more specific. They'll spell out everything from how many lenders the purchaser agrees to try (in case the first one falls through), what interest rate is acceptable and more.

For the buyer, this can offer protection against being obligated to a deal that he or she really can't afford. It also offers protection if the appraisal on the house comes back lower than expected.

For the seller, a mortgage contingency clause also has benefits. If a buyer doesn't manage to make a deal with a bank within a reasonable time frame, the deal can be canceled without fear of penalties. Most mortgage contingency clauses require the buyer to make a reasonable effort to obtain the necessary financing.

If the buyer doesn't comply with the terms of the clause, the seller can keep the earnest money or down payment the buyer has already made on the property and put the house back up for sale. If the buyer does comply with the contingency clause and still can't get the loan, then the earnest money is returned.

Sometimes, in a tight market, sellers will ask buyers to provide proof that they are "prequalified" by a bank before they accept an offer. In a really hot market, they may even ask a prospective buyer to waive the mortgage contingency clause. That's a gamble that you want to think carefully about before you agree to take it.