Are you ready to take on the real estate market, but feeling a bit overwhelmed by all the jargon and terminology?
Don’t let tricky words like “contingencies” make you feel intimidated.
In fact, understanding what contingencies are in real estate could be your key to getting the home of your dreams at an unbeatable price.
Contingencies provide potential homeowners with leverage during negotiations – so it pays off to familiarize yourself with these important clauses before diving into a transaction!
In this blog post, we’ll answer the question, “what are contingencies?” and explore how they can help secure an ideal outcome for everyone involved in a property transaction.
How do Real Estate Transactions Work?
Buying and selling real estate isn’t all that different from any other business transaction, but there are a few more steps involved.
First, a potential buyer submits an offer on the house.
The seller can then either accept, reject, or make a counteroffer.
Negotiations between the two parties take place until everyone is happy with the terms (or someone walks away).
In most cases, this is all done through real estate agents.
If the buyer is serious about the deal, they need to submit an earnest money deposit which typically ranges from 1% to 2% of the sale price.
Once this is done, the closing process begins.
During this time, essential steps like inspection and appraisal take place.
The final contracts are signed, and the buyer finalizes their financing for the deal.
With a bit of strategizing and a good agent by your side, the home buying process is actually pretty straightforward!
What are Contingencies in Real Estate?
When buying a property, there are a lot of terms and clauses included in the contract, and it’s important to understand the contingencies.
A contingency clause is a special condition that allows parties to back out of the contract under certain conditions.
Essentially, a contingency clause can provide an escape hatch if certain things don’t go as planned.
But what kind of conditions can a contingency clause have?
They can range from something as simple as the buyer having a certain number of days to inspect the property, to more complex terms like securing a loan at a specific interest rate.
It’s important to make sure that the terms are clearly written for both parties to understand.
What happens if the conditions of the contingency clause aren’t met?
The contract becomes null and void, and the buyer can back out without any consequences.
But if the conditions are met, the contract is legally binding, and backing out of the deal could lead to serious consequences such as lawsuits or forfeiting the earnest money.
So, as a buyer, it’s important to understand the contingencies in your contract and make sure you’re comfortable with the conditions before signing on the dotted line.
Contingency Rules for Real Estate Contracts
Contingency contracts make sure that certain conditions are met before a deal is sealed.
This leaves room for negotiation, compromise, and sometimes, confusion.
You don’t want your home purchase to fail because you don’t get the basics of a contingency contract.
To protect your future investment, it’s important to learn about all the necessary elements of a contingency contract.
This way, you’ll be able to navigate through the process smoothly and avoid costly mistakes.
Contingency Contracts are Conditional
Contingency contracts are a vital part of the real estate world.
A contingency contract can be valid based on whether tasks are completed or avoided.
It’s important to understand that contingencies for different real estate contracts can vary.
For instance, homeowner’s insurance acts as an excellent example of a contingency plan.
Consider a scenario where the insurance agency would pay you a certain amount if any damage occurs due to a flood.
In this situation, the money is contingent upon the property damage.
If there is no flood, then the insurance company won’t provide you with funds.
In essence, contingent contracts are based on specific conditions, and it’s crucial to keep this in mind when dealing with any real estate transaction.
Base Contingencies on Specific Events
For a contingency contract to be successful, the stipulations must be specific and measurable.
Otherwise, it won’t hold up in court.
Let’s say you’ve got a real estate contract with a contingency that the property needs to be improved.
What does “improved” mean, and according to whom?
A direct contingency, like the inclusion of a clause that says “if the seller repairs the leaky pipes, then the property will be sold,” is a better solution.
It cuts down on any confusion or disputes regarding what needs to be done.
Contingencies Need Deadlines
Successfully closing a real estate deal requires planning and collaboration.
You don’t want to spend months waiting for the process to conclude, which is why having a timeline for contingencies is critical.
This approach ensures that both parties fulfill their obligations and helps the process flow smoothly.
The Agreement Should be Binding
As a homebuyer, it’s always wise to take steps to ensure that a contingency contract is official and binding.
This not only provides protection for all parties involved but also ensures that each contingency is met.
It’s important to remember that it’s not advisable to simply “take someone’s word for it” at the closing table.
Instead, put the contingencies in writing so that both parties have a clear understanding of what needs to be done.
This helps ensure that all conditions will be met and also provides a framework for what to do if not.
With these steps in place, you can invest with confidence knowing that you’re protected and well-informed.
Most Common Contingencies in Real Estate
There are a variety of contingency clauses that can be added to a real estate contract.
Below are some of the most common contingencies in real estate.
1. Appraisal Contingency
Real estate contracts often contain an appraisal contingency that is crucial to the deal.
This clause provides two options for buyers: back out of the deal if the appraisal value is lower than the purchase price, or renegotiate the price with the necessary backing to decline.
Typically, a licensed appraiser is tasked to estimate the value of the property and create a report with an attached appraised amount.
The bank’s loan amount is dependent on this appraisal value, with any shortfall falling on the buyer.
For example, if a home is valued at $500,000, but the asking price is $600,000, the bank would loan the former amount, making it the buyer’s responsibility to cover the difference of $100,000.
Therefore, it’s imperative to understand the appraisal process to make informed decisions and avoid any unwanted surprises.
2. Financing Contingency
One common stipulation you’ll often see in real estate contracts is the financing contingency.
In simple terms, this clause means your offer is dependent upon your ability to secure financing.
It will outline specific aspects of the financing, such as the type, terms, and length of time to obtain approval.
So, why is the financing contingency so important?
Well, let’s imagine you’re about to close the deal and your loan falls through.
Without the financing contingency, you could be in a hairy situation, potentially risking your earnest deposit and facing other consequences.
But, thanks to this clause, you can walk away from the deal without any trouble.
It’s also worth noting that sellers often prefer cash buyers because they don’t require financing.
But, with the financing contingency in place, you can still make a strong offer even if you’re not able to buy with cash.
Additional Financing Resources:
- Mortgages 101: The Definitive Guide to Home Loans
- Mortgage Pre-Qualifcation vs. Pre-Approval: What’s the Difference?
- Mortgage Loan Process: A Step-By-Step Guide to Home Loans
- 13 Mortgage Shopping Mistakes to Avoid When Buying a House
3. Home Inspection Contingency
The inspection contingency – also called a “due diligence contingency” – offers buyers peace of mind when purchasing a home.
Essentially, it gives the buyer the right to have the home inspected by a professional inspector within a timeframe, such as five to seven days.
An inspector examines the property’s interior and exterior, analyzing everything from the condition of electrical and plumbing to the house’s structural integrity.
This all comes together in an inspector’s report, which outlines any issues discovered during the inspection.
Here’s the good news: depending on the inspection’s findings, the buyer has a number of options.
They can approve the report, and the deal can move forward as planned.
Alternatively, they can disapprove the report, back out of the deal, and receive their earnest money back.
If time is needed for additional inspections, the buyer can request it.
Similarly, if repairs or a concession are needed, the buyer can request them.
If the seller agrees, the deal still moves forward; if the seller refuses, the buyer can back out of the deal without penalty.
In some circumstances, a cost-of-repair contingency may be included.
This specifies the maximum dollar amount of necessary repairs.
If the home inspection indicates that repairs will cost more than this dollar amount, the buyer can choose to terminate the contract.
In many cases, the cost-of-repair contingency is based on a certain percentage of the sales price, such as 1% or 2%.
Whether you’re a new or experienced home buyer, knowing what an inspection contingency entails is vital for making informed decisions about your purchase.
To learn more about home inspections check out our list of the 13 Most Common Home Inspection Issues & How to Spot Them
4. Home Insurance Contingency
When it comes to buying a home, there are plenty of contingencies to consider.
One of the most critical is home insurance, which lenders and sellers often require buyers to obtain before closing the deal.
But what exactly does this insurance cover?
Simply put, home insurance is designed to protect your investment against property damage, fire, natural disasters, and other potential issues.
Unfortunately, actually obtaining insurance for your new property is not always easy.
In certain regions of the country, insurance companies have become more reluctant to insure properties.
That’s where the home insurance contingency comes in.
By including this condition in your contract, you ensure that you have the option to back out of a deal if you cannot secure insurance before closing.
It’s a small detail that could end up saving you a lot of money and headaches in the long run.
5. House Sale Contingency
When you’re selling your house and buying a new one, there’s a common contingency that relates to the buyer’s financial situation.
This contingency notes that the sale of the new house will only happen if the current one sells first.
While this can protect you, it might not make sense for the seller in a seller’s market.
After all, they might prefer to choose a buyer who doesn’t have this restriction.
But don’t panic!
You don’t have to be a cash buyer to purchase your new home before selling your old one.
Your mortgage lender could offer a bridge loan or other financial solutions.
Another workaround is to ask for a later-than-normal closing date.
This buys you more time to sell your house, but could result in some sellers rejecting your offer if they’re in a hurry to close the sale.
On the other hand, this might be attractive to other sellers who want to finish the school year in their current home or are still searching for their next dream home.
6. Kick-Out Clause
When selling a house, you might worry about what to do if a buyer asks for a house sale contingency contract.
To protect yourself, consider using a kick-out clause.
This handy contingency allows you to keep marketing your property while the contingency contract is in place.
If your buyer can’t remove the house sale contingency within the specified time, you’re free to walk away from the contract and offer the house to another qualified buyer.
7. Title Contingency
Getting a new home can be an exciting but nerve-wracking time, and we want to make sure everything goes smoothly!
That’s why it’s important to have a real estate attorney or title company perform a title search before the purchase to ensure a proper record of homeownership.
The good news is the majority of title issues can be cleared up ahead of time.
However, a few complications could occur.
For example, the seller might have a lien on the property or face an ownership dispute.
To protect yourself from these possibilities, consider a title contingency.
This allows you to withdraw your offer if any issues remain unresolved at the time of closing.
With a little preparation and know-how, you can make sure the home-buying process is a resounding success!
Final Thoughts on Contingencies in Real Estate
In conclusion, contingencies are an important factor to consider when buying real estate.
They can help protect buyers from potential risks associated with purchasing a new home and can be used as an important negotiation tool.
Knowing the different types of contingency rules, being aware of them when in contract negotiations, and discussing them carefully with your team is key.
With that knowledge, you should now have a comprehensive understanding of how to handle contingencies when it comes to buying or selling real estate.
If you need further advice or guidance with buying or selling a property then talk with an experienced real estate agent.
Finding a real estate agent to trust and rely on when buying or selling your home is essential.
With over six decades of success behind us, you’ll surely have peace of mind knowing your best interests are being represented each step toward buying or selling a home.