What Is A Financing Contingency And Do You Need One?

Buyer and seller on trains heading to the closing but the buyer has a switch labeled Financing Contingency to change tracks and avoid the closing

When you’re getting ready to buy a New York City apartment, one of the most important offer terms to consider is a financing contingency. We often find buyers first learn about financing contingencies when we’re helping them draft the offer. We’ve put together the basics so you can dive into the details of your offer(s) with your real estate agent and/or attorney.

Table of Contents:

What is a financing contingency?
Does a financing contingency eliminate mortgage risk?
Why wouldn’t you ask for a financing contingency?
Why appraisals are often a sticking point for financing contingencies
What to do if the seller won’t agree to a financing contingency
Financing contingencies on new development

What is a financing contingency?

A financing contingency or mortgage contingency protects the buyer from losing their deposit if they cannot get a loan. It is the most common form of contingency in NYC and written into the purchase contract, subject to specific details. If a financing contingency is exercised, the buyer cancels the contract and their deposit is returned.

Requests for a financing contingency should be made with your original offer as it is a deal term that will be considered by the seller. If you try to add a financing contingency later on, the seller will likely say no.

Does a financing contingency eliminate mortgage risk?

In NYC, a financing contingency usually only protects the buyer until they receive a commitment letter. This is generally within 30 days of signing the contract. Given it takes 60-90 days to close, that still leaves time for things to go wrong.

When you receive the commitment letter, it will contain contingencies. Generally, the gist is nothing bad can happen before closing. For example, you can’t lose your job. If you do, your lender will not make the loan. Each contingency will be explicitly listed in the commitment letter.

The only exception is a low appraisal. Sometimes lenders will complete their underwriting prior to the appraisal and issue a commitment letter pending that piece of information. Most financing contingencies require an appraisal be completed for it to be satisfied.

A financing contingency is still very valuable though. In order to receive a commitment letter, your lender will complete a thorough underwriting of your financials as well as the building’s financials. A financing contingency protects you from any surprises from the building and any earlier misunderstandings between you and your bank. You'll also have a way out if the appraisal comes in low.

Buyers often get a financing contingency confused with a funding contingency. A funding contingency is more comprehensive and allows the buyer to cancel the contract if they cannot get the money to close for any reason. Funding contingencies are exceptionally rare in NYC.

Why wouldn’t you ask for a financing contingency?

Sellers don't like financing contingencies because they give the buyer a way out. No seller wants to go through the time and expense of signing a contract and taking the property off market only to go back to square one a month later. Because of that, all else equal, a seller will choose an offer without a financing contingency.

This is similar to why sellers prefer cash buyers. A loan presents the opportunity for more issues before closing.

Anecdotally, we would say a financing contingency will cost you a few thousand dollars. For example, if you are offering $750,000 with a financing contingency and another buyer is offering $748,000 without one, the seller may opt for that to be sure the deal goes through.

Every buyer’s situation is different though and you should review yours with your agent. They should be able to tell you how the seller will view a request for a financing contingency.

Why appraisals are often a sticking point for financing contingencies

A common reason loan applications are rejected is a low appraisal. An appraisal is your lender’s way to make sure you’re paying a reasonable price for the property. To understand how an appraisal can derail a loan, it’s helpful to run through an example.

Say you are buying an apartment for $1,000,000 and your bank's max loan to value (LTV) is 80%. In other words, they require 20% down. The financing contingency will say the you can cancel the contract if you can't get a loan for $800,000.

But then there’s a problem - the appraisal comes in at $950,000. The bank doesn’t care how much you’re paying. As far as they’re concerned, the apartment is worth $950,000. Since their max LTV is 80%, they will only give you a loan for $760,000 (80% of $950,000). That's $40,000 less than you need so the financing contingency kicks in and you can cancel the contract.

The key there is you can cancel the contract. It's your choice.

The process has gone a long way at this point. You and the seller agreed on the terms, signed the contract, etc. But as the buyer, you’re in control. As long as you have another $40,000, you can choose to go forward, usually in exchange for a lower price.

Conversely, if the appraisal comes in at $1,050,000, the seller can’t try to raise the price.

As long as you have a financing contingency, the appraisal presents a free option for the buyer to renegotiate the price. An appraisal is simply one person's opinion on a given day so they can vary widely. This uncertainty is why sellers sometimes push back on the appraisal, provided you can supply additional funds.

What to do if the seller won’t agree to a financing contingency

Especially if there are multiple buyers, sellers will sometimes turn down financing contingencies. It would be easy to assume there is no deal if you are firm on getting one and the seller is firm on rejecting one. However there is a compromise that sometimes gets the job done.

If you offer to make a larger down payment, should it be necessary, it basically eliminates the unpredictable appraisal from the contingency.

In the example above, you can say you want to put down 20% but if the appraisal comes in low, you’ll put down up to 30% or $300,000. Since you can still get a loan for $760,000, there is no problem.

If you lose your job or the world falls apart, you’ll still be protected. Sellers understand those concerns and are less likely to push back.

Financing contingencies on new development

Getting a financing contingency in a new development is tricky because of the timeline. If you receive your commitment letter in a month and deliveries aren't expected until next year, that leaves a lot of time for something to go wrong. For this reason, new developments often do not agree to financing contingencies.

If you are focused on new development but also want a financing contingency, your best bet is to focus on buildings that are completed or close to it. Timelines there will be shorter and therefore less risky.

You can also ask for a funding contingency but even in a weak market, sponsors rarely agree to them.

This post is for informational purposes and should not be used as legal advice. Please speak to your attorney to review your particular transaction and situation.