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.

  • Curiousbuyer

    “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.”

    So the request to waive the financing contingency (in wa state) is the right to terminate notice, correct? Is that 3 business days or 3 calendar days from the delivery of the right to terminate? If the notice was delivered on Thursday, when is the deadline?

    • I can’t comment on specific timelines in your contract, without seeing the actual contract.

      Assuming the Form 22A Financing Contingency was used, the seller can issue the “right to terminate notice” after the specified period of time has passed. That notice says “if buyer does not waive the financing contingency, seller may terminate this agreement any time 3 days after delivery of this notice”.

      If the buyer doesn’t waive financing, the seller must send a notice of termination to actually terminate the agreement. Note that a seller does not HAVE to terminate. It just gives them the ability to do so.

      If you are using the standard NWMLS language, a notice delivered on Thursday with a 3-day response will not include the weekend, so the seller could terminate after Tuesday.

      If you are in the midst of a contract, read the exact terms outlined there. All of this can be changed and negotiated, so don’t go off of some advice on a blog without reading your own documents.

  • Curiousbuyer

    Thanks. If I had the documents I would be sure to read them. Here’s my situation, I am in a back up offer position. I understand the seller has sent the notice to the buyers in 1st place requesting they waive their financing contingency. How much time do the buyers have to respond to that notice? Whatever timeframe the seller decide? Is there a standard timeframe i.e 5 days? 3 days?

    • The way that addendum works is a bit odd. Once the seller requests the buyer waive their financing contingency, the seller may terminate the transaction any time after 3 days from delivery of that notice. (weekends not included)

      However, if the seller never issues a terminate notice, the deal keeps going. The buyer does not technically have to respond. They just run the risk of the seller terminating the deal at some arbitrary point in time. (which is not super common for sellers to do)

      If the buyers in 1st position really want the house and are confident in their financing, they would likely waive the contingency to avoid the risk of the seller cancelling the deal. It could also be a bit of a bluff by the seller to request the waiver of financing contingency, without the intent to actually issue the terminate notice.

      If I were a seller, and I had a reasonable level of confidence with the buyer in 1st position and their financing, I would be hard-pressed to terminate the deal because they wouldn’t waive the financing contingency. Far more preferable to close on time, rather than to have to reset the whole clock with a backup buyer. There are instances of buyers with dicey financing where this game makes sense, but if they are well-qualified, ask yourself what it accomplishes for the seller to force the issue when the buyer is certainly going to get a loan.

  • Gustaf Karlholm

    Thanks for a great description on form 22A. I have used it for years and thought I knew it well.
    The form actually have a major flaw as I see it.
    In point 4 of the form it states exactly what a buyer needs to provide to get his/her earnest money back if the loan was denied.
    Apart from a good faith effort to get a loan, the buyer needs to get in writing from the lender, not the mortgage broker, 1. the date the loan was applied for, 2. that the buyer had sufficient funds to close, and 3. the reason for denial.
    What any lender will give you is a letter of denial, so that takes care of number 3 above. They are standard letters with checkboxes for the different reasons for denial and they do not go into any other aspects than the reason for denial.
    When it comes to 1 and 2 above the lender could get that information from the mortgage broker who is the one who took the loan application.
    Many lenders (all I have talked to) will refuse to write anything else than the standard letter as it would possibly open them up to other liabilities.
    So if the buyer is unable to get 1. and 2. above from a lender the seller can keep the Earnest Money.
    In practice if you get a letter of denial you would get your Earnest Money back, but right now Windermere is enforcing a strict interpretation of this form. This basically means that if you are using a mortgage broker you never really had a financing contingency, as it is very unlikely that you as the buyer, or your mortgage broker, would be able to get the required letter. So you really never had a way to get the Earnest Money back. Oops.

  • Gabriel Flores

    What is the timeline for a response from the Seller after the buyer files a Form 22AN, Notice of low appraisal, for the Seller to comply and or satisfy the appraisal requirements for the Buyers loan approval? When can I determinate the contract based on the Sellers failure to obtain an appraisal?