Understanding the Conditions of Financing

Before listing your home, it’s important to understand how financing conditions work and the risks that come with buyers waiving them.

By Emily Southey | 9 minute read

Real estate agreements often come with conditions. One of the most common conditions sellers must be aware of is a financing condition. Since most buyers can only afford to buy a home with the help of a mortgage loan, financing conditions are usually included. Though such conditions are generally designed to protect the buyer, they can have benefits for the seller as well. 

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What Is a Financing Condition in Real Estate?

A financing condition is a clause that makes the home sale contingent on the buyer’s ability to secure the necessary financing. In most cases, the financing condition hinges on the buyer’s ability to obtain a mortgage loan from a mortgage broker or lender. Financing conditions, along with other types of conditions like home inspection, are typically included in the purchase agreement. This agreement will also stipulate a time frame that the buyer has to get approved for their mortgage. This time frame is usually five to seven days from the date of the offer. If the buyer’s financing is denied, they fail to get approved before the expiration date, or the approved amount is not enough to cover the sale price, the seller has the right to walk away. 

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From the seller’s perspective, firm offers (those that are free from conditions) are typically more attractive, as they often lead to faster sales. However, this isn’t guaranteed, and firm offers can also fall through. For example, if the seller receives a firm offer but the buyer isn’t able to obtain the necessary mortgage loan, the deal could still fall through but with much greater consequences. In such a scenario, since the buyer doesn’t have a financing condition to protect them, cancelling the deal could have serious ramifications, such as a lawsuit. While a lawsuit might result in the seller getting the money they were promised, it would significantly draw out the selling process and cost a fortune in legal fees. 

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Meanwhile, from a buyer’s perspective, a financing condition protects them (and their earnest money deposit) by allowing them to retract their offer if they are unable to secure the necessary financing. Since mortgage approvals are not guaranteed, even if you’ve been pre-approved, it’s always wise for buyers to include financing conditions in their purchase agreements. In essence, conditional financing acts as an insurance policy.

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Why Conditional Financing is Important

Though sellers are not required to accept an offer with a financing condition, it is often good practice to do so because of the protection it offers buyers. To help sellers understand a buyer’s mindset, we’re outlining why conditional financing is so important for buyers. 

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First and foremost, financing conditions protect buyers. Most buyers can only afford to purchase a home with the help of financing. If they put in an unconditional offer on a home and their mortgage loan falls through, they likely would not have the means to pay for the home themselves. The exact wording of financing conditions varies, but generally, it conveys to the seller that the buyer’s offer is conditional on them obtaining the necessary financing. If they are unable to obtain such financing, they are within their legal rights to walk away from the offer. Therefore, a financing condition protects the buyer from losing out on their deposit or being sued, both of which have serious financial ramifications. 

Scenarios when financing conditions are beneficial to buyers

There are multiple scenarios where having a financing condition can be hugely beneficial to buyers. Three of these scenarios are as follows: 

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• If you don’t get approved for a mortgage: Remember that mortgage pre-approval is not the same as mortgage approval. At the end of the day, pre-approvals are estimates, not guarantees. So even if you’ve been pre-approved for a certain amount, a mortgage lender can still reject your application when it comes time to formally submit one. Though the odds of this are low, it does happen, especially if the formal application process reveals a poor credit history or undisclosed debt. In addition, if a buyer’s circumstances have changed since pre-approval, such as losing their job or taking on new debt, like a car loan, your application could be denied altogether. In such a situation, having conditional financing will be your saviour. 
• If your mortgage approval is for a smaller amount than you expected: As mentioned, mortgage pre-approvals are not guaranteed. Therefore, you could end up being approved for a lower amount than you were pre-approved for. Depending on how much lower the amount is, it could be the difference between being able to afford the home you submitted an offer on and no longer being able to afford it. If a buyer is approved for a smaller amount than expected, they will need to decide between submitting a larger down payment or walking away from the sale. But they will only have this choice if a financing condition was included in the purchase agreement. 
• If the home appraisal is low: One final scenario in which financing conditions benefit buyers is if the home appraisal is lower than expected. When obtaining a mortgage loan, most lenders require the buyer to pay for a home appraisal. This is the lender’s way of making sure the home is worth what the buyer has offered to pay. Nine times out of 10, the appraised value matches up with the offer being made. But sometimes, this value will be lower than the offer price. If this happens, the buyer might be on the hook for paying the difference in price (the difference between the appraised value and the purchase price). Not all buyers can afford to do this. Luckily, if they can’t afford it, buyers can walk away from the deal if they have a financing condition.

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The Risks of Not Including a Finance Condition in Your Offer

For buyers, many risks come with not including a financing condition in their offers. Although you might think a seller will understand and be willing to cancel the deal in the event that you can’t secure financing, this isn’t always the case. Plus, if you submitted a firm offer, then you are under a legal obligation to proceed with the purchase, and the seller would be within their rights to sue you if you refused to pay. A few of the possible risks that come with submitting a firm offer include: 

The buyer losing out on their deposit 

The first and most common consequence of not including a financing condition is that the buyer will lose out on their earnest money deposit. This deposit is usually between 1% and 5% of the purchase price, which is not an insignificant amount. If you fail to obtain the necessary financing and try to back out of the home sale, the seller may keep your deposit. 

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The buyer is forced to follow through with the sale anyway

If you submit an offer without a financing condition and it’s accepted, you might be legally required to proceed with the home sale. So even though you were unable to obtain a mortgage loan and therefore may not have the means to pay for the home, you may be legally required to pay for it. This would leave you scrambling to find a way to purchase the home or risk a lawsuit.

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The buyer is sued 

Lastly, one of the most serious risks of not including a financing condition in your offer is being sued if you back out of the sale due to financing issues. If your offer was not conditional on financing, then the seller might be within their legal rights to sue you for loss of income.