A real-estate contingency can make or break a deal. Although (in rare cases) they can hold up a sale, contingencies are a common, and usually inconsequential, part of the total sales process.
Whether you are a buyer or a seller, understanding contingencies will make you better informed about the real-estate industry and contracts.
What are Contingencies in Real-Estate Sales?
Essentially, a contingency means that the buyer (or in some cases the seller) has to do something before the contract is official. The buyer may have to perform certain tasks or wait for someone to complete an application or document.
A contingency makes the contract null and void if certain events happen (or don’t happen) in the process. In a way, it can be considered an escape clause that allows the agreement to be called off, all without a penalty to the would-be buyer and the home seller.
Almost all real estate contract have some type of contingency language, and they can be proposed by both the buyer and seller. Contingencies can include virtually any aspect of the home sale or condition of the property, but there are type of contingencies that are far more common than others. (We will explore common types below.)
Why They Exist: Breaking a Contract Without Contingencies
To really understand contingencies, it helps to know why they exist. For most real-estate sales, the buyer and seller come to an agreement and sign a contract. The buyer puts up a “good faith” deposit, which is kept in escrow (the amount varies), then the seller takes the home off the market, putting the brakes on showings and active listings. If, for whatever reason, the buyer backs out of the sale, the good faith money is given to the seller, essentially acting as payment for the time and hassle of stopping the sales process without selling the home. So if a buyer backs out because they decide they simply don’t like the house anymore, the seller gets to keep the good faith money.
But if there is a legitimate reason, outlined in the contract, the buyer can recover their money without purchasing the home. These legitimate reasons, once defined in the contract, become the contingencies.
Types of Contingencies
Financing
The most common type of contingency deal with the mortgage. In most contracts, there is language describing how the transaction will only be complete once the mortgage is officially approved. Not only must financing be approved, but it will need to be within the basic terms and conditions described in the contract. These terms are usually determined during pre-qualification.
The type of loan, as well as the length of the loan (30-year vs 15-year, for example) is often described in the contract. The contract may have language stating that the offer to buy is contingent on the buyer being approved for a 15-year conventional mortgage with an interest rate no more than 4.5%. (Or something to that effect, the details can vary widely.) So if rates suddenly rise, or a personal credit situation drives a spike in the interest rate, the buyer may be able to back out without penalty. (Again, a lot is dependent on how the contract is written.)
The financing contingency is usually little concern thanks to pre-qualification. If a buyer has already spoken with a lending agent or a credit union, their financial and credit information has already been reviewed (a brief review, but a review nonetheless), so assuming nothing has changed and the purchase is within the financial bounds of the pre-qualification, the buyer will most likely receive final approval for the loan.
Contingent on Appraisal
An appraisal helps the buyer and lender understand the fair market value of a property. Appraisal contingencies are designed to allow buyers to back out of a sale if the agreed-upon price is significantly higher than the appraised value. Obviously buyers are interested in this value, but lenders need this information as well. In the rare event that a mortgage goes into foreclosure, lenders need to know that the property on which they are lending will be able to bring enough to compensate the loan.
Home Inspections and Repairs
Home inspections are crucial to the sale of a home, and many real-estate deals are contingent on an inspections and subsequent repairs. For obvious reasons, buyers don’t want to purchase a home with a long list of expensive problems. Therefore, they will likely include an inspections contingency. Essentially, this contingency says that once the inspection is complete, the buyer can request specific repairs or updates to the property. This contingency often allows the buyer to demand new terms or repairs to the property. The buyer can also back out of the sale if terms are not met. The seller also has the chance to reject the post-inspection terms and terminate the contract if he or she wishes to do so.
Current-Home Sale
It’s common for buyers to be unable to purchase a home until after their current residence is sold. A contract may have a contingency saying that the buyer will purchase the new property assuming their current property is sold by a specific date. If the buyer is unable to sell their old house, they are able to back away from the purchase without penalty.
This contingency can create a lot of trouble for sellers, so it’s one that many agents try to avoid. In a cool market, where homes stay available for months, sellers may be less likely to accept this contingency. However, if the market is hot and a sale is all but guaranteed, the seller is more likely to accept. In some cases, a bridge loan can be used to help the buyer stay financially afloat until after their home is sold.
Increase Your Chances of Approval with Our Common-Sense Approach
At San Diego Purchase Loans, we take a common-sense approach to mortgage approval, treating your application with care and attention. We look at the whole picture, and take the time to examine details that increase your chances of approval.
Contact us today and discover how our service and dedication can help you get the right loan for your next home!
