Financing Contingency

A clause stipulating that the purchase offer is contingent on securing financing

What is Financing Contingency?

In a home sale and purchase agreement, financing contingency refers to a clause that expresses that the offer is contingent on the buyer securing financing for the property. A financing contingency provides the buyer with protection from potential legal ramifications in case the deal fails to close.

 

Financing Contingency

 

Financing Contingencies in Strong and Weak Markets

Markets vary in the demand for property and its availability thereof. The existence of contingencies differs depending on the status of a given market. In a market with a huge demand for properties, the sellers would pick the offer with fewer stipulations and contingencies. On the other hand, if the demand is low, the seller faces fewer options and would, therefore, choose an offer regardless of the number of contingencies. The seller also considers the value of an offer in terms of the amount of money. A seller would choose the offer from the highest bidder.

The seller becomes the determining factor especially in the cases where there is high demand for their prime property. The seller must weigh the stipulations, contingencies, and the value of an offer to sell their property. An offer to buy a property will often contain several contingencies concerning appraisal, financing, and others. The buyer should also be aware that there are other competing offers for the same property. Usually, many buyers choose to scrap off some contingencies to beat the competition. A buyer may choose to overlook their right to ask for appraisal or financing related contingencies which raises their probability of being chosen by the seller.

Buyers should be aware of the financial risks such moves bring on board. Competing for the property is healthy but exposes the buyer to obvious and some unforeseen challenges. For instance, waiving financing-related contingency would deny the buyer the help of a financier in the purchase of a house. Some contingencies are also mandatory according to existing laws, which means that overlooking such would attract a lawsuit. Buyers also risk losing their earnest money and far more reaching consequences. The wording of the clause in the offer is paramount and can mean the difference between making a killing in a bid as opposed to facing severe financial risks.

 

Earnest Money

Earnest Money is a down payment on a property placed when a buyer submits an offer to a seller. The down payment is common with buyers as a way of showing commitment and interest in the property purchase. Earnest money is not mandatory, but many buyers use it as a convincing stance to the seller in the quest to woe them to choose their offer as opposed to their competitors’ offer. The amount ranges from 1% to 5% of the sale price. It is often presented in the form of a cheque. The funds are first held in an escrow account or by the real estate agent until the seller accepts the offer. In case the buyer is unable to complete the purchase, the money is returned to them.

 

Purpose of a Financing Contingency

A financing contingency shields the buyer if they are unable to secure financial support. It is usually detailed on matters concerning financing, and it is specific concerning all predictable conditions and stipulations. The main aim of a financing contingency, however, is to shield the buyer from being penalized in the event that they are incapable of completing the purchase when they already won the bid. The existence of contingencies differs depending on the status of a given market. In a market where the demand for property such as houses is high, the sellers will pick the offer with fewer stipulations and contingencies. On the other hand, if the demand is low, the seller faces fewer options and would, therefore, choose an offer despite the number of contingencies.

The financing contingency contains clauses that specify the dates of the completion of the transaction. The contingency also highlights expected instances and the resultant events. For example, if the buyer is unable to secure funding in time, the contingency requires that the held earnest money be refunded to the buyer with no deductions. The clause also stipulates that the buyer is not liable for any obligations if they fail to secure funding.

Since the financial contingency shields the buyer from certain financial obligations arising as a result of their lack of capacity to obtain funding, the seller is required to be careful. The seller should investigate the buyer’s ability to complete the transaction promptly before accepting any offer. In case the buyer fails to complete a transaction, the seller loses valuable time and energy, as well as other offers posted by other buyers. It is, therefore, important that the seller chooses an offer they are sure that the buyer is most likely to complete the transaction.

 

Letter of Intent (LOI)

A Letter of Intent is a term sheet that initiates the process of purchase of the offer from a buyer to the seller. A financing contingency, therefore, is a clause found in the LOI laying out the basis for cushioning a buyer from losing their earnest money as a penalty for not completing the purchase or being sued for damages, especially by the seller. In the case where a buyer is sure of their financing status, it is advisable to waive the financing contingency to be highly competitive in the bid for the property. It is also desirable that all buyers use a financing contingency in their LOI to cushion themselves from financial risks.

The financing contingency also allows enough time for the buyer to secure financing. The seller cannot cancel the buyer’s offer in case of delayed funding. Therefore, using a financing contingency is safer for a buyer throughout the process of purchasing a home. It is also not necessarily disadvantageous for a seller to choose an offer with a financing contingency. The offer might be worth the wait even in the event of delayed financing.

 

More Resources

CFI is a global provider of financial modeling courses for finance and accounting professionals.  CFI also offers a Financial Analyst Certification program for those looking to take their careers to the next level.

Additional, relevant resources from CFI include:

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