Common Contingencies in Real Estate
Buying a home can be an exciting time, but it also has some risks. When you make an offer on your dream home, you will have to pay a deposit to the seller. This deposit is known as earnest money, which you can lose if you are unable to close on the home. Though to protect this earnest money, there are contingencies.
These contingencies are clauses or conditions that need to be completed before the closing date. When the seller accepts a buyer’s offer, both parties will agree to a home purchase contract that could include multiple contingencies.
This contingent offer means that certain things need to happen before the sale can be completed. The purchase contract will set out these contingencies and the amount of time available to complete them.
If these contingencies are not met, the contract can be canceled. This gives responsibilities to the buyer and seller to fulfill what was agreed upon in the contract.
The buyer’s responsibilities could include ensuring they are approved for the financing they need and arranging for a home inspection and appraisal. There will only be a limited amount of time to deal with these things as set out in the contract.
The seller’s responsibilities might include giving access to a home inspector and not accepting offers from other buyers. These contingencies mainly protect the buyer, ensuring they don’t unfairly lose their earnest money, but there can be some benefits to the seller as well.
Earnest money is a good faith deposit that gives the seller the confidence to take their home off the market. This gives the buyer time to go through the home buying process to get to closing. If the buyer backs out of the deal, the seller could lose money, but the earnest money offers the seller some protection.
Earnest money is typically 1% to 3% of the purchase price, though in some situations it can be higher. If the buyer finds that they can’t continue with their purchase, canceling the contract will mean they lose this earnest money. But contingencies can prevent this financial loss.
How Many Contingencies Should You Include in the Purchase Contract?
While including every relevant contingency in your agreement with the seller might seem like a good idea, it probably isn’t. Though this provides a lot of protection, it isn’t going to make your offer look very attractive to the seller. Unless you are home buying in a buyers market, where sellers are struggling to find someone who wants their home, sellers will be put off.
While we look at a lot of contingencies in this article, you won’t want to include all of them in your purchase contract. Many of them will be unnecessary or things you can safely do without.
It is better to choose a few contingencies that you really need, and make compromises on others that have a more acceptable risk.
Each Contingency has a Time Limit
Your purchase contract with the seller will have a closing date, and most of the contingencies will also have a deadline for completion. This will help to keep the purchase on track to meet the closing date, but it could mean you only have days to meet your requirements in each contingency.
When you have signed a purchase contract, there will be a gap until the closing date, often known as the escrow period. During this time you might need to schedule a home inspection and secure financing.
You will need to keep the seller informed of your progress, and if something goes wrong, renegotiation might be required to get things back on track. This could mean the closing date changes, but it could also mean you have to decide whether you want to remove the contingency or back out of the purchase completely.
Let’s look at some of the most common home buyer contingencies.
Home Inspection Contingency
When you buy a home, having it inspected by a certified home inspector is always recommended. They will search the home looking for potential problems that could end up costing you a lot if they are discovered after your purchase.
They will check all parts of the home, possibly finding defects in the structure, foundations, roof, HVAC, or anywhere else. If a major issue is found the home inspection contingency allows you to walk away from the purchase.
The buyer will have a short period to hire a home inspector, and if there are problems found, they will have to make a decision. The buyer can walk away, negotiate with the seller to reduce the price or ask for repairs to be made.
Most buyers need financing to purchase their home, and this can sometimes go wrong. Buyers can get pre-qualification or pre-approval from their lender before beginning their search.
Of the two, pre-approval is better and gives a clearer understanding of the home loan the borrower will receive. Pre-approval is a deeper look at the homebuyer’s finances, though it is still an estimate of what they can afford.
While they might have been given preapproval from their lender, this doesn’t guarantee the borrower will be approved for that size loan after they have made an offer.
If the home buyer does something that changes their financial situation, like taking out a new loan or losing their job, the mortgage they need to buy the home might not be available. While they might be able to get a suitable mortgage approved with another lender, this may not happen. In this situation, the financing contingency lets them back out of the purchase with their earnest money.
When an offer is made, the mortgage lender wants to make sure they aren’t loaning more than the home is really worth. The lender doesn’t want to find themselves in a situation where the home has to be foreclosed, and they lose money because it isn’t worth the amount that was loaned.
To reduce the chances of this happening, an appraisal is required. But if the appraiser finds that the home is worth less than the offer, the lender might refuse to loan all of the money. If that happens, the buyer can still buy the home if they can make up the difference. Though if they can’t do that, they will need an appraisal contingency to keep their earnest money when backing out of the purchase contract.
This situation can be more of a problem in fast-moving markets where homes are in demand. The appraiser will use comparative market analysis to help find the value of the home, and if prices are rising quickly, the sales data they are using won’t be up to date.
Either a real estate attorney or a title company will check for issues in the title of the home before closing. The report that they create will show a history of ownership and if there are any liens or judgments on the title.
If there are liens, it could mean ownership of the home will be disputed at some point. The seller will need to make sure these are cleared before closing, or the title contingency will allow the buyer the back out of the deal.
Home Sale Contingency
If the buyer has to sell their current home before they can purchase the new property, a home sale contingency might be used. This gives the buyer time to sell their home by a certain date. If the home doesn’t sell in time, the buyer can back out with their deposit returned.
This contingency is not popular with sellers, and consequently, isn’t used that often. It can mean their home sale hangs in limbo while they wait for the buyer’s home to sell. They might also wait for a long time and still need to find a new buyer when the contingency is triggered.
If you are waiting to sell your home, when you make an offer, the home sale contingency will protect your earnest money. However, there is likely to be pressure from the seller to drop this contingency.
If you are competing with other buyers to purchase the home, this contingency is going to make your offer look worse. Even if you have offered more for the home than another buyer, the seller might prefer a lower offer without a contingency which could delay the closing date.
While most of the contingencies benefit the buyer, this one benefits the seller. When the seller has accepted an offer with contingencies, the kick-out contingency (AKA bump clause) gives them the option to cancel the first purchase contract and go with a new buyer.
If the buyer chose to include a home sale contingency, the seller could be waiting around for a while. But if they have a kick-out clause, they can continue marketing their home. If another offer is made, they can give the first buyer a short amount of time to either drop their contingency and buy the home, or cancel the purchase contract.
Home Insurance Contingency
Before a lender will approve your mortgage, they need to know that you have a home insurance policy. This insurance policy will make sure there is coverage after the seller has moved out of the home. If something was to happen that caused serious damage to the home, the lender would be protected and able to recover the loan amount.
If for whatever reason, the buyer isn’t able to get this insurance policy before closing, they can cancel their purchase. Without a home insurance policy, the lender isn’t going to provide financing for the property, and the homebuyer is unlikely to be able to close.
Homeowners Association Contingency
If the home is within a homeowner’s association, this contingency can give the buyer the time to review the HOA agreements and covenants. Homes within an HOA can have restrictions and requirements that not everyone will want to agree to.
The homeowners association contingency will allow the time to review documents and decide if you want to live under those restrictions. This contingency could be useful if you expect to close on the home quickly and haven’t been able to check the HOA agreement and covenants before making your offer.
How Do Contingencies Benefit Buyers?
When buying a home, there can be surprises and not necessarily good ones. If you find out that the home has significant cracks in the foundation, you might not want to continue with the purchase. And without a home inspection contingency to protect you, walking away from the transaction will lose you money.
Choosing the right contingencies to go with your offer will make sure you get your earnest money deposit returned if something like this goes wrong.
Summing Up Common Home Buyer Contingencies
Entering into a real estate transaction is a big financial commitment that could also have big risks. Contingencies are a way of protecting the buyer’s earnest money deposit, allowing them to walk away from the contract if things aren’t as expected or don’t work out as planned.
Since most contingencies benefit buyers, sellers often want to avoid them. Though it might be tempting to remove all the contingencies to make your offer as attractive as possible, this leaves you in a difficult position if you suddenly discover problems with your purchase.
Instead of choosing every contingency that could protect you during the transaction, only selecting the most important is a better compromise. It will make your offer more attractive to the seller without leaving your earnest money at risk.
About the author: This article on “Common Real Estate Contingencies” was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generate new leads from his website.
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