Once upon a time, nearly every home purchase contract had a "loan contingency" or a "mortgage contingency". What this meant is that the sale couldn't move forward without a mortgage. If the buyer couldn't get a mortgage on the house, they got their earnest money back and the contract was void.
Today, things have changed. The norm is to be a pre-approved for a loan.
Nonetheless, there are still plenty of occasions when a loan contingency needs to be used. The usual reason is because the lender needs to make sure that home fits their financing needs.
Here are some loans will frequently have a loan contingency on them.
- VA loans - Guaranteed by the Veterans' Administration, these homes need to meet a specific set of guidelines.
- FHA loans - Also guaranteed by the federal government, there are often some very strict guidelines for FHA houses.
- Conventional loans - These loans, from banks or mortgage brokers, are often sold on the secondary market and therefore need to be provably valuable.
- Credit union loans - Because credit unions are using member funds to make loans, they often have more stringent requirements than conventional banks.
- Hard-money loan - These are private financing loans for cash. The lender may want proof that the home is worth the purchase price.
The purpose of loan contingencies
The entire purpose of a loan contingency is to delay the closing until certain criteria are met. In most cases, the lender will order an appraisal, and sometimes a second one before the loan funds. This is done to prove that the house is worth the purchase price.
There is a frequently used appraisal contingency. The buyer might have released this contingency, but if the lender is not satisfied, the loan contingency can be used to delay the closing until the appraisal is completed.
The downside of loan contingencies
The negative side of loan contingencies are that when the seller has multiple offers on the table, they might simply take the one that has no or fewer contingencies. They might even take a lower price to do this, but this way they can be assured of the sale.
Many buyers have begun asking the lender to get underwriter approval before the buyer even makes any offers. This removes the uncertainty of financing. No contingency is needed.
Should you avoid loan contingencies?
In many cases, it's best to have all the approval process completed before you even go out shopping. Other times, it's unavoidable. An FHA or VA loan may require that you take time to get a second appraisal.
To be certain that you know what will be expected, speak to your lender. If you know that any house will have a loan contingency on it, you won't get excited enough to simply pack up your belongings as soon as you see the right house.