When Purchasing a House: Understanding Loan Contingencies and Why You Should Never Waive Them

When buying a house, one of the most critical decisions you will make is whether to waive your loan contingency. This article delves into the details of loan contingencies and the importance of not waiving them until you have a secure loan approval. Understanding your rights and protections can significantly impact your home-buying journey.

Understanding Loan Contingencies

A loan contingency is a provision within the purchase contract that allows the buyer to walk away from the deal if they do not secure financing. These contingencies are sometimes jokingly referred to as “weasel clauses,” but they serve a vital purpose in protecting both buyers and sellers. The most common types of loan contingencies include:

Loan contingency: The loan is subject to the buyer’s application and approval under terms at least as favorable as those outlined in the offer. Appraisal contingency: The buyer can back out if the appraised value of the property is less than the purchase price. Inspection contingency: The buyer can cancel the agreement if issues discovered during the home inspection are not addressed by the seller. Sale contingency: The sale is contingent on the buyer selling their current property.

Each of these clauses gives the buyer the flexibility to back out of the deal without losing their down payment if unexpected issues arise.

The Most Important Loan Contingency: Understanding Its Impact

The loan contingency is arguably the most significant because it directly impacts the buyer’s ability to proceed with the home purchase. This contingency has a specific timeframe, often 17 days, within which the buyer must obtain the financing. However, in some cases, the seller might insist on a shorter time frame.

Once the buyer applies for a loan, the lender will review the application and may impose certain conditions for approval. Some of these conditions, known as “deal conditions,” can include:

Updated bank statements or pay stubs Letters of explanation for employment gaps or income fluctuations Documentation of large deposits

These conditions are not always easy to satisfy, and failing to meet them could result in loan denial. Therefore, it is essential to wait for approval or a “Clear To Close” status before removing the loan contingency.

A Case Study: The Risks of Removing the Loan Contingency Too Soon

A few months ago, we encountered a scenario where a buyer needed to refinance her current property to secure funding for a new one. Her earnest money deposit was 28,500. Unfortunately, after referring her to us, another lender had admitted they could not provide the loan, and she had already removed her loan contingency, leaving a hefty sum at stake.

The complexity of her situation was evident: she owned another rental property nearby, and her bank statements showed large, unidentified deposits. Some of these were gifts from relatives, but others were unexplained cash she had lying around. We were able to document the gifts but could not accept the cash deposits as they were not acceptable to any lender.

Another challenge was the requirement for substantial cash reserves. This is a requirement of Fannie Mae and Freddie Mac, who can ultimately buy the loan. Refinance proceeds and gift funds are not acceptable as cash reserves. We had to document nearly 50,000 as required reserves, a requirement which necessitated statements from her retirement fund, allowing up to 70% of the balance to be considered as reserves.

The buyer's earnest money deposit was at risk if she could not secure financing, and we had to provide detailed documentation to the underwriter to approve her home purchase.

Best Practices for Safeguarding Your Home Purchase

Based on the case study, it is clear that removing the loan contingency too soon can have severe consequences. Here are some best practices:

Wait until you have a secure loan approval or a “Clear To Close” status. Document any gifts and large deposits appropriately. Seek professional advice if you are unsure about your loan contingency. Communicate openly with the seller and real estate agent about potential risks.

By following these guidelines, you can protect your investment and ensure a smooth home-buying process.

Conclusion

When purchasing a house, it is crucial not to remove your loan contingency until you are certain of getting the necessary financing. This ensures that your deposit is secure and that you can proceed with the transaction without undue risk. Understanding the loan contingency and following best practices can significantly impact your home-buying journey.