Financing Contingencies Unveiled

Financing Contingency

Let’s say you decide to buy a house and find the perfect one, put down thousands of dollars in earnest money and then a week or two later your lender calls you up and says you don’t qualify. Are you able to get that earnest money back? Or is it gone forever?

Earnest Money Deposit

When buying a home it is expected for you to put down a deposit known as earnest money. This amount shows that you are a serious buyer and that you are willing to put some skin in the game. Sellers are reluctant to accept an offer that ties up their home for a month or more unless they know you are serious and there are some repercussions for not going through with the purchase. This earnest money is typically 1% of the purchase price of the home. It is then held by a neutral third party known as a title company that helps manage the paperwork side of things. 

Buyer Protection

First off, it is important to note that here in Texas we have a very buyer protection heavy contract. The contract that we use for residential sales is written by the state government and it has over 40 ways for buyers to get out of the contract along with getting their earnest money back. We have another article that discusses many of these contract outs. You can read it here. 

So, back to the topic at hand. You find the perfect home. For example, maybe that costs $500,000 and when you make the offer you agree to put 1% or $5,000 down in order to secure that contract. Then 10 days later you get the call that your loan has been denied. So do you get the money back? The answer is, it depends. 

The Third Party Financing Addendum

When buying a home in Texas, the contract has a specific addendum to deal with typical financing. This is called the Third Party Financing Addendum. There are other addendums for specific types of financing such as seller financing but the vast majority of time the Third Party Financing Addendum is used.

Within this addendum there are 2 separate parts relating to approval. One for Buyer Approval and the other for Property Approval.

Buyer Approval

Paragraph 2 A deals with buyer approval. This approval is all about the buyer’s ability to pay back the loan. It includes such things as credit score, income, existing debt and how all that relates to the loan amount and monthly payment. There are a number of different loan types and the requirements vary depending on which one is used and this addendum requires some of this information to be disclosed to the seller up front. Things such as loan amount, type of loan, interest rates, loan length and lender costs.

Financing Info

Now Paragraph 2A has 2 different selections. One selection says “This contract is not subject to buyer obtaining buyer approval”. So basically with this checkbox, the buyer is saying that they don’t need to get approved for a loan and don’t need a contingency to allow them to get out of the contract if they fail to obtain a loan. There are a couple reasons this might be used, but it is risky so please don’t do it unless you are confident in your ability to get a loan. One reason this might be done is if the buyer is getting a loan but has the money to pay for the house in cash if they need to. Another reason might be that the lender has already fully underwritten the buyer and given approval ahead of time. 

Buyer Approval

However, in the vast majority of cases, we will want to use the other selection that states the buyer needs to obtain approval. Along with this is a blank that needs to be filled in stating the number of days that the buyer has to get this approval. Typically this will depend on the lender. Some might only need 5 days or so while others might need a few weeks. So make sure to discuss this with them before moving forward. Years ago 21 days was very common but in 2020-2022 we often saw 10 or less. 

Be careful with your lender though. If you are dealing with a local lender then it shouldn’t be too big of a deal, but large national lenders often don’t have the familiarity with our contracts and often don’t care the number of days we have for approval. I have been told on multiple occasions that they will get to it when they get to it regardless of the contract timelines. This can lead to sticky situations. 

Property Approval

The next part, Paragraph 2B is the property approval. Property approval includes things such as appraisal, insurability, property condition, and anything else that might stop a lender from approving the loan for the property. 

Property Approval

You might wonder why the lender is concerned about the property condition. Well, this is dependent on loan type, but in particular government loans such as FHA and VA require the property to be in habitable condition. They are protective of the buyer and also don’t want the buyer walking away from a money pit. If you are using a rehab loan then things are a bit different. Be sure to check out our article on Rehab Loans

This paragraph is a bit different. Rather than a blank with a negotiated number of days this paragraph states that the buyer has up until 3 days before closing to get this approval. This gives plenty of time for the appraisal to be completed along with the title commitment to insure there are no ownership issues. 

So What About the Earnest Money?

Both of these paragraphs state that if the buyer terminates within the timeframe and does so under one of these parameters the earnest money will be refunded to the buyer. So back to our original questions, whether or not the buyer receives their earnest money back is dependent on the timeframe of termination along with the reason. Be aware that the contract states that the lender must deliver a denial in writing. But as long as this is followed, the sellers will have no claim to the earnest money. 

Hopefully you now have a better understanding of what financing contingencies. Please contact us if you have any questions. As always, if you are looking to buy or sell a home please reach out to us. We will gladly assist you. 

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