An Overview of Common Real Estate Contingencies
When a real estate agent or broker puts together the purchase agreement for your home, they will talk with you about a variety of supporting and supplemental documents. These may include a letter from your lender, the payment of an Earnest Money Deposit (EMD), and, in most cases, one or more contingencies that will accompany your contract.
Contingencies are optional agreements covering specific aspects of the real estate transaction. Usually, they are designed to allow one or the other party to a real estate transaction to exit the transaction without paying a penalty or taking on liability for ending the sale or purchase. In the buyers’ case, this penalty would usually involve relinquishing the EMD to the sellers. In the sellers’ case, this penalty might come in the form of damages paid to the buyer. The contingency provides the option of walking away, if necessary.
In some heated situations, homebuyers may be tempted to waive common contingencies in order to streamline the transaction and reassure the buyer of their good intentions. This can be financially risky, especially if there are undisclosed problems with the home or uncertainties involved in the transaction itself. It’s essential that you consider all the eventualities—and the potential price—of waiving any contingency.
1. Home Inspection Contingency
Perhaps the most commonly used contingency is that related to the home inspection. This offers buyers an opportunity to bring in an inspector of their choice to look at the home’s structure and systems in order to determine what repairs or improvements need to be made. At that point, the buyer can negotiate repairs or seek an amount of compensation in lieu of repairs to be applied to the transaction’s closing costs.
In multiple offer scenarios, it may be tempting to waive a home inspection in order to sweeten the offer and reassure sellers that you intend to see the transaction through to completion. However, this could lead to difficulties if you find out later that the home has significant problems. Instead, it may be a good idea to implement the home inspection contingency “for information only” so the sellers won’t need to respond to a list of repair requests.
2. Finance Contingency
The finance contingency states that the buyer will be applying for a mortgage and offers the ability to walk away from the transaction if they are unable to secure financing. Cash buyers will not use a finance contingency but will supply proof of funds with their offer.
It is a good idea to obtain a mortgage preapproval from your lender before making an offer on a home. Not only will it make your offer more competitive, it can keep you from moving forward with a transaction then finding out that you are unable to obtain the necessary funds.
3. Appraisal Contingency
An appraisal is normally ordered by the lender and offers them reassurance that the home is worth the amount they are providing to you. In some heated bidding wars, buyers may choose to waive the appraisal contingency, especially if they are confident the home is priced appropriately. However, this is not the same as waiving the appraisal, which the lender will require in most cases.
Cash buyers are not required to have an appraisal conducted but may choose to do so in order to reassure themselves about the home’s fair market value. This may be especially common in the purchase of an investment property, where it is important to have a solid property valuation in order to accurately gauge its investment potential.
4. Home Insurance Contingency
The purchase of home insurance is normally required by the lender, so a home insurance contingency is common. This ensures that, before closing, the buyer will obtain a homeowners insurance policy to protect the purchased property. The insurance premium will often be wrapped into the mortgage payments, paid in monthly installments, and held in an escrow account for payment to the insurance company when due—often twice yearly.
5. Home Sale Contingency
In some cases, the buyer may be shopping for a home before selling his or her current home. This may necessitate the use of a home sale contingency stating that the seller will wait and close on the property once the buyer has sold their current residence. While this type of contingency is uncommon in a hot seller’s market, it may be appropriate in cases where the seller has a longer timeline for moving or in cases where the buyer’s current home is located in a particularly desirable location.
6. Kick-Out Clause
The kick-out clause helps to ensure that the sellers retain some control, even when there is a home sale contingency in place. This allows them to continue showing the home and to entertain subsequent offers from qualified buyers. That way their home sale will not be held up due to a lengthy home sale process on the buyer’s side.
7. Title Contingency
In many cases, state requirements ensure that a title search is conducted prior to closing in order to provide a clear chain of ownership for properties. A title contingency allows the buyer to walk away if there is a dispute or discrepancy in regards to the property’s title, ensuring that they don’t find themselves having to pay down the road to “quiet the title.”
There may be additional requirements, clauses, or contingencies employed in your particular market. Talk to your trusted real estate professional to better understand how contingencies apply in your case. If you have additional questions about liability resulting from the waiver of common contingencies in your market, consult a real estate attorney.