Mortgage Contingency Clause Contract Modifications - Finding A Balance

The majority of home buyers borrow about 80% of the purchase price from a lender of their choice.

As a result, the standard contract of sale language for single family homes, condominiums, and cooperative apartments include a provision called the mortgage contingency clause which primarily protects buyers by allowing them to exit the contract without penalty if they cannot secure financing despite good-faith efforts.

It establishes a specific timeframe, usually 30 – 45 days, and other loan parameters that must be met. The clause balances interests by protecting buyers from purchasing without financing while giving sellers assurance through required prompt application efforts and the right to cancel if no commitment is secured by the deadline.

Once a commitment is issued, the buyer is bound to the contract even if the lender later fails to fund, placing that risk on the buyer.

However, many attorneys who represent buyers will attempt to further mitigate their clients’ risks by modifying the standard contingency language to state the buyer may cancel the contract and receive a refund of their deposit if the lender refuses to fund the loan for any reason. While rare, this may occur due to different circumstances:

Circumstances where a lender might refuse to fund a mortgage loan after a commitment is issued include:

Change in borrower's financial situations. If the buyer’s financial situation changes after the commitment letter was issued and they no longer meet the conditions for approval, a lender can withdraw its offer. This could include job loss, decreased income, or taking on new debt.

New credit activity. Applying for new credit can push a buyer over the 43% DTI ratio maximum preferred by most lenders. This includes opening new credit cards or taking out other loans between commitment and closing.

Credit score changes. One problem is if a buyer’s credit report changes. Sometimes people will buy new furniture for their new home, and it puts them over the limit.

Failure to meet conditions. Most mortgage commitments are conditional, which means there's a list of conditions to be met for the commitment to be fulfilled. If a buyer doesn’t fulfill these requirements, the lender may not proceed.

Employment verification issues. Lenders verify employment up to and including the day of the closing, and a job change before closing could delay the sale or turn an approval into a denial.

The problem with such modifications is that it shifts a buyer’s risk onto the seller. In other words, if the standard contingency language is modified and the lender refuses to fund the loan a few days before closing thereby allowing the buyer to cancel the deal without penalty, now the seller is back to square one in that they have to start the process all over again.

This is an inequitable outcome which our office typically advises sellers to avoid by either rejecting any modifications to the contingency clause or, in the alternative, further modifying the proposed edits to obligate the buyer to find another lender in the event the first lender refuses to fund the loan.

Keep in mind, it is extremely rare that lenders refuse to fund loans after the initial commitment is made in which the appraisal contingency has also been satisfied. At the same time, it is understandable that a buyer, especially a first time home buyer, does not want to risk the potential loss of a contract deposit which is usually 10% of the purchase price. However, it’s also unreasonable to require a seller to lose an offer that’s in contract because a buyer failed to satisfy loan conditions or who engaged in behavior that impacted their credit.

Accordingly, allowing a buyer another 30-45 days to obtain financing from another lender seems to provide a reasonable balance between the interests of the two parties.

If you’re either buying or selling, give us a ring or shoot us an email. We represent both buyers and sellers in all real estate matters in the Lower Hudson Valley area, the five boroughs of New York, and Long Island.