A sale pending sign stands in front of a house in North Andover, Mass., in 2019. Parties in a real estate contract should look closely at the financing contingency clause and modify it to be reasonable and enforceable. (Elise Amendola/AP)

By Harvey S. Jacobs

July 20, 2020 at 9:00 a.m. EDT

In the home-buying process, buyers and sellers should negotiate to write contingencies into their contract to mitigate risk. For example, sellers may want to condition their obligation to sell on finding and purchasing another home. Buyers who are financing a portion of the purchase price will want to insert a financing contingency clause. Buyers also commonly make their purchase offers contingent on receiving satisfactory inspection reports describing home condition, radon levels, well and septic system safety and functionality, where applicable, and absence of wood-destroying insects. Contingency clauses excuse a party’s obligations to go to settlement if the contingency is not met or waived.

Buyers should include only those contingencies they really need. Too many contingencies will make their offer less attractive to sellers, and in a competitive market, it can cause them to lose the desired home to competing offers.

While most contingencies are fairly straightforward, the financing contingency addendum used by the Greater Capital Area Association of Realtors is complicated and often misunderstood. The addendum creates a term called the financing deadline, by which the buyer must deliver a written loan commitment. Contrary to what sellers might expect, buyers’ failure to meet the financing deadline does not cause the buyer to be in default, does not automatically void the contract, and does not allow the seller to retain the buyer’s earnest money deposit.

If a buyer fails to make a timely loan application, fails to comply with a potential lender’s requests or otherwise fails to take steps required to obtain a timely lending decision, that can be deemed a default. It can also be considered a default if the buyer intentionally takes steps during the loan process that imperil the loan decision, like quitting a job or incurring large debts to buy a car or other major purchase. In those cases, the seller should have the right to retain the buyer’s earnest money deposit and/or sue for additional damages.

The financing contingency addendum provides that the contract will remain in force until the seller delivers its notice declaring the contract void. Sellers might erroneously conclude that if they want to retain the buyer’s earnest money deposit, they should send a notice declaring the contract void, but another GCAAR contract clause states that is not the case: “If this contract becomes void, without default by either party, both parties will immediately execute a release directing that the deposit be refunded in full to the buyer.”

So what should savvy sellers do to protect their interest in the earnest money deposit while still allowing the buyer’s lender time to properly underwrite its decision?

  1. Sellers should modify the financing contingency clause in their contract to clearly identify the circumstances that allow sellers to retain the buyer’s earnest money deposit and when they must return it.
  2. The seller should require the buyer to apply for financing within 10 days from the contract date and provide the seller with its lender’s written loan commitment 30 days thereafter.
  3. The contract should specify the lender, loan amount, interest rate, term and whether the interest rate is fixed for the life of the loan or can adjust. Each of those factors impacts the parties’ risk.

A large loan amount in relation to the purchase price makes the loan riskier for the lender and less likely for the buyer to be able to qualify. The buyer must also agree to provide information in a manner that allows the lender to make a timely loan decision.

Buyers need to carefully consider their at-risk earnest money deposit that accompanies the purchase offer; the larger the earnest money deposit, the stronger the offer. Buyers need to meet their financing deadlines. They should work closely with their lenders before making a purchase offer and provide information to their lender to ensure the financing deadlines can be met. Buyers should work to get preapproved, a higher level of verification from the lender, vs. prequalified. The buyers should include the preapproval letter in their purchase offer.

If buyers and sellers understand the financing process and their rights and obligations, they will be in a better position to negotiate a reasonable and enforceable financing contingency clause in their purchase and sale contract.

Harvey S. Jacobs is a real estate lawyer with Jacobs & Associates Attorneys at Law LLC in Washington. He is an active real estate attorney, investor, landlord, lender and settlement attorney. This column is not legal advice and should not be acted upon without obtaining your own legal counsel. Contact him at jacobs@jacobs-associates.comwww.jacobs-associates.comask@thehouselawyer.com, or call 301-417-4144.