Understanding Contingencies in Real Estate — A Complete Guide
There is a common foe shared amongst buyers and sellers in real estate, and that would be an over-abundance of paperwork filled with acronyms, abbreviations, and unintelligible legalese. As your real estate agent, I can aid you in decoding this said paperwork, but having a basic understanding of some important concepts will help you feel empowered when it comes to your hand in real estate.
What is a Contingency?
To start, the question you might be asking yourself is, what is a contingency? To put it simply, a contingency is an "if-then" agreement: "If these things happen, then I will buy your house." Contingencies will be negotiated between both parties, sellers, and buyers, though they exist primarily for the buyer's protection. For example, if the agreed-upon conditions aren't met, the buyer can walk away scotch-free of any legal or financial repercussions. What about the sellers? Contingencies do shield sellers as well. For example, if the conditions are met and the buyer tries to renege on the contract, they will be in danger of losing their deposit.
Understand What You're Signing
Contingencies are common when it comes to real estate transactions, especially since they are useful to both a buyer and a seller. As we mentioned above, with a large number of documents and papers to sign, it might be tempting just to skim over the details and sign away. Don't give in to that temptation. Contingencies are legally binding documents, and missing even a single deadline can bring dire financial or legal consequences to your door. Be sure that you are always aware of what you are signing. If it is helpful, remember that contingencies of any type should always be the following:
- Mutually agreed upon by both the buyer and seller.
- Written in easy-to-understand language with timeframes and terms indicated in specifics.
- Crystal is clear when stating the conditions under which the prospective buyer's earnest money/deposit is to be refunded.
The Four Main Types of Contingencies in Real Estate
1. Home Inspection or Due Diligence
This contingency allows a buyer to have the property they are considering buying inspected by a professional inspector before finalizing the purchase. If the inspection uncovers any problems, the buyer has the opportunity to either back out of the deal or ask the seller to address the said issues. If the parties both reach an agreement about the repairs to be made and the seller follows through, then the buyer is legally bound to fulfill the sale contract.
Our Tip— Never waive a home inspection as a buyer. The cost of the inspection comes directly from your pocket, though a good home inspection is far less costly than an expensive fix to a house you just bought.
This contingency allows time for the home to be appraised professionally, protecting the buyer from entering into a sales contract a lender might not approve. If a seller is asking for $500k for a home that appraises for only $300k, the buyer would have to come up with the difference in cash. To protect the buyer from this situation, buyers can rescind their offer when appraisals come back below the asking price.
Our Tip— If the said appraisal comes back lower than the asking price and you have no desire to lose the home, you can always request a second appraisal. If your contingency is properly worded a re-negotiation of the purchase price can be made so that it fits the appraisal.
3. Financing or Mortgage
This contingency allows the buyer more time to secure financing for the purchase. If the buyer cannot come up with a loan, they can withdraw from the contract without repercussions. This particular contingency can be a frustration for the seller, though it is still in their best interest. At the end of the day, there is no point in going into a sales contract with a buyer who can't afford the house.
Our Tip— From a buyer's perspective, seek pre-qualification from a mortgage lender so a rough outline of a reasonable purchase budget. This method can save you and the seller both time and irritation.
4. House Sale
This contingency provides buyers time to sell their current home before they fulfill the contract for the new property. Particularly useful to buyers, this contingency protects them from ending up with two mortgages to pay if their current home does not sell before the closing date on the new one. There is a drawback for sellers, that being an "under contract" sign appears in their front yard, but there is no guarantee the deal is done.
Our Tip— As the seller, consider including a "kick out" clause in the house sale contingency, allowing you to continue to market your home and entertain offers from other prospective buyers. If another qualified offer is given by a different potential buyer, approach the said buyer and request a moved contingency with a time frame (42 hours). If refused, the seller can walk away from the contract and the home can be sold to a new buyer.
Make sure that all the contingencies used in real estate are worded correctly and enforceable through the use of a knowledgeable and experienced real estate professional. The right real estate partner will help you to stay on top of terms, and timelines, and answer any questions you might have about buying or selling a home.