Financial contingencies inject an air of uncertainty into the home-selling process. After all, what are the chances that every piece of a complex financial transaction will fall into place even before you add in conditions?
Around 85% of home buyers use a mortgage to purchase their home, so chances are good that you’ll receive offers with financing contingencies when you place your home on the MLS. Here’s how to prepare yourself for navigating the selling process when the buyer’s offer is contingent on specific financial conditions.
What Are Financial Contingencies?
Think of contingencies as an “if — then” statement. If the buyer doesn’t like the inspection report, then they can walk away. If the appraisal doesn’t come in at the right price, then the offer is null and void.
A variety of these “if — then” statements can be written into the offer, but these are some of the most frequent financial contingencies typically included:
- Sale Contingency- A buyer who first needs to sell their house before purchasing yours may include a sale contingency. This is an indication that they want to buy your house, but they can back out of their offer if their house doesn’t sell by a certain date.
- Settlement Contingency- Taking it a step further, a settlement contingency means that a buyer already has a contract on their property, but they’re waiting for it to close. If their property falls through, they can withdraw their offer on your home.
- Mortgage Contingency- Even with a pre-approval letter, the buyer could still fail to secure a bank loan. A mortgage contingency allows them to terminate the contract if they’re unable to receive financing.
How Risky Are Financial Contingencies?
Risk assessment in this situation will come down to whether you’re in a buyer’s or a seller’s market.
You may decide to accept financial contingencies in a buyer’s market because you don’t have that many competitive offers. Therefore, waiting for a buyer to get their financial ducks in a row won’t significantly increase your home’s time on the market. In this instance, there is considerably less risk for you because your options are limited.
In a seller’s market, financial contingencies make an offer less competitive. Why accept an offer that might fall through when you have five other offers on the table with no contingencies? Removing your home from the market while waiting on a buyer’s financing could mean delaying your home sale, and if you’re on a tight deadline to sell your home, that delay could cost you time and money.
Pro-tip: Protect yourself by writing hard deadlines into the contract. Leaving an offer contingent on a buyer’s financing without providing an end date will drag out the negotiation process.
Assess the Quality of the Buyer
A prepared buyer will be ready to prove that they have their finances in order. Here are some questions you can ask:
- Do they have a preapproval letter from a financial institution?
- Can they put down earnest money?
- Do they have a down payment?
- What kind of loan do they have?
- If the buyer already owns a home, have they listed their home for sale?
However, some questions violate the Fair Housing Act. Avoid questions that reveal a buyer’s relationship status, race, or religion. Be sure to consistently use the same criteria to evaluate every buyer; using different criteria to evaluate different buyers is discriminatory and against the law.
When in doubt, lean on your real estate agent’s expertise to be sure you’re not biased against a buyer.
Does the Type of Home Loan Matter?
The majority of home loans fall into three categories: conventional bank loans, FHA, or VA loans.
Both FHA and VA loans are backed by the federal government, and subsequently, they have slightly different rules than conventional bank loans. They don’t require large down payments, they allow lower credit scores, and they have more stringent requirements for the properties that are purchased.
There is a misconception that FHA loans are less likely to close, but the data doesn’t conclusively support that idea. There is also a myth that FHA and VA loans take longer to close, but a well-trained lending team can fund these loans in the same amount of time as a conventional loan.
Even though there are no significant differences between the three major types of loans, many Realtors® continue to favor conventional loans in the negotiation process. While you weigh the offers on your house, just remember that the type of loan the buyer has should be a negligible factor in your decision.
How Home Sellers Can Protect Themselves From Financing Contingencies
By agreeing to financial contingencies, you’re exposing yourself to the risk that the home buyer won’t follow through and purchase your home, but there are some steps you can take to mitigate that risk.
The earnest money is a small down payment by the buyer, and it signals their intentions to complete the purchase. If the buyer breaks their side of the contract, by either missing a deadline or failing to secure financing, the seller keeps the earnest money.
Also known as a knock-out clause, the kick-out provision allows the seller to continue marketing the home after accepting a buyer’s offer. If a better offer comes along, the seller can kick out the previous buyer and accept the superior offer.
The Bottom Line
Choosing to work with a buyer that has financing contingencies will take some luck and a little trust. Will they come through with financing? Or will their financing contingencies hold up the entire sale?
Deadlines and contract clauses that protect you will reduce the risk you assume when you allow contingencies. As much as possible, lean on the trusted advice of a real estate agent to guide you through the negotiation process.
Disclaimer: This post was not written or reviewed by a professional financial advisor, and the suggestions should not solely be used to make financial decisions.