Understanding the finance contingency in Washington state

Home buyers often include a financing contingency in their offer to purchase a home. The purpose of this contingency is to protect the buyer’s earnest money deposit in the event that they are unable to obtain a mortgage. You may make an earnest money deposit of 1%-3% at the time of offer acceptance. If you back out of the deal for no contractual reason, the seller will retain this money as damages.

financing contingencyMost real estate sales in Washington state are consummated using NWMLS forms. It is one of the more confusing forms we use and is widely misunderstood by home buyers and their real estate agents. I am going to write very specifically about the mechanics of the finance contingency in Washington state. If you are a reader from another state, I have no idea what the standard finance contingency looks like in your area, so use the contents of this post with caution. I’m sure yours will be different.

Key financing contingency terms

Our finance contingency contains a number of terms that are specified at the time of offer:

  1. Loan type – conventional first, conventional second, VA, FHA, etc.
  2. Down payment amount
  3. Number of days for formal loan application to be made.
  4. Seller-paid loan costs

In order for your finance contingency to remain valid, certain key conditions must be met. You must make formal loan application within the number of days that you have agreed upon, normally five. You cannot change the loan type without seller’s prior written consent, and you cannot change your lender after application without seller’s prior written consent. Said another way, if you are pokey about your loan application or change lender mid-stream without the seller’s OK, you have waived your financing contingency and will not get your earnest money back if you fail to obtain a mortgage.

How long does your finance contingency last?

This is by far the most misunderstood portion of the finance contingency. In the offer, the buyer and seller will agree upon a time frame when the seller can issue a “Right to Terminate Notice.” Typically this is 30 days from mutual acceptance, but could be negotiated differently. Basically once that time period passes, the seller is allowed to send the buyer the “Right to Terminate Notice,” which states that if the buyer does not waive their financing contingency, then the seller can unilaterally terminate the agreement at any time after 3 days have passed. There is no requirement that the seller issue this notice, and if they do not, the financing contingency will remain valid through closing.

Here are the various scenarios:

  1. Seller never issues the “Right to Terminate Notice” – the financing contingency will remain valid all the way until the closing of the home, regardless of the time frame specified for issuance of the notice.
  2. Seller issues the “Right to Terminate Notice” but does not terminate the agreement – a risky situation for the buyer to possibly lose the property, but the finance contingency remains in effect.
  3. Seller issues the “Right to Terminate Notice” and buyer waives their financing contingency – The buyer can no longer retain their earnest money if the transaction fails due to lack of financing. The seller also cannot unilaterally terminate the agreement.
  4. Seller issues the “Right to Terminate Notice” and then issues a “Termination Notice” three or more days later – The agreement is terminated and the earnest money gets refunded to the buyer.

Buyers want the longest period possible for issuance of the “Right to Terminate Notice” and sellers want it to be short. The reality is that few sellers ever issue that notice. Sometimes it is because they don’t understand the contract, but in most instances, it is more important for a seller to retain the current buyer than risk scaring them off by being too aggressive in their request to remove the finance contingency.

If your mortgage application fails, how do you get your earnest money back?

In the unpleasant event that you are declined for a mortgage, there is a specific set of paperwork that you must provide to the seller to get your earnest money back. Your lender must document when you applied for the loan, that you possessed sufficient funds to close and the reasons that the loan was denied. If you can’t produce these documents, the seller gets to retain your earnest money.

What if your appraisal comes back lower than the sale price?

Our finance addendum in Washington state also includes a process for what happens if the bank’s appraisal comes back lower than the purchase price. In this instance, the buyer would give notice that they will terminate the agreement unless the seller does one of the following:

  1. Obtains a reappraisal or reconsideration of value at the seller’s expense – In the past, this was often done with another appraiser, but with today’s tight mortgage guideline, the only real option without applying to a new lender is to appeal the appraisal results with the current appraiser.
  2. Seller reduces the purchase price to the amount specified in the appraisal.

The appraisal contingency protects the buyer from having to come up with a larger down payment and gives the option to terminate the agreement when this happens. However, there is nothing to stop a buyer from paying the shortfall resulting from the lower appraisal if they still want to buy the home and the seller will not agree to the lower price.

Consult your agent and lender

Protecting your earnest money from a failed mortgage application is an important buyer protection. The best protection is to be confident in your ability to obtain a mortgage before ever placing an offer on a home, which means you should be pre-approved at the beginning of the process. Once you are in the process, make sure you understand the provisions of the financing contingency and pay attention to deadlines specified by your lender and real estate agent so that your earnest money remains protected.