Let’s say you’re selling your home. You get it ready for showings, take professional photos, choose a top listing agent, and finally get it on the market. You receive an offer from a buyer, accept it, sign a purchase agreement, and the buyer puts their earnest money down. The closing process begins. As the seller, you’re home free, right?
Well, not quite. Nearly every purchase agreement contains contingencies that, if they aren’t satisfied, can result in a canceled sale. The good news is that if you understand how these contingencies work, you can prepare for them in advance — and avoid unpleasant surprises or disappointments just short of the finish line. This is one of the biggest reasons to work with a good real estate agent who can explain the ins and outs of the transaction, and help you avoid pitfalls.
Let’s talk about what exactly a contingency is, and review some of the most common contingencies.
What is a contingency?
A contingency is a clause in the purchase contract that gives parties the right to back out of the sale if certain conditions aren’t met.
Most contingencies benefit the buyer. The most common contingencies are inspection contingencies (that protect the buyer from getting stuck with a problem-ridden home) and financing contingencies (that allow the buyer to walk away if they can’t secure financing). While seller contingencies aren’t unheard of — one of the most common contingencies for sellers specifies how long the seller can stay in the house before moving out — they’re much less consequential than buyer contingencies.
If you’re selling a desirable property in 2022’s red hot seller’s market, you might be able to demand a purchase agreement that’s free of contingencies. But refusing to accept any contingencies will drive off some buyers, especially high-quality cash buyers who buy and sell houses for a living. And the truth is that most contingencies shouldn’t cause you much concern, especially if you know you’re selling a solid property.
Let’s touch on some of the most common contingencies and how they work.
The home inspection contingency
This very common contingency gives the buyer the right to order a home inspection (usually within a certain timeframe). If the inspection uncovers problems, it allows the buyer to negotiate remedies or walk away from the sale.
The inspector will examine the home closely, looking at the interior and exterior for signs of problems like mold, termites, structural damage, or age-related deterioration. They’ll also look at major systems like plumbing, electrical, and heating/cooling.
If the inspection uncovers problems, the buyer can ask you to have repairs done (often by a contractor of their choosing), or negotiate a concession—basically, a discount on the sale price in the amount of the cost of repairs.
If you can’t come to an agreement, or the problems are simply too daunting, the buyer can walk away from the sale with their earnest money.
Inspection contingencies are sometimes accompanied by a cost-of-repair contingency, which lays out a maximum acceptable total cost of repairs, often 1% to 2% of the total sale price. If the total cost of repairs exceeds the amount specified in the cost-of-repair contingency, the buyer can walk away.
The mortgage financing contingency
This contingency is extremely common—and extremely reasonable. It gives the buyer a certain amount of time to secure financing for the home purchase. If they fail to do so, they can walk away from the deal with their earnest money. If a buyer doesn’t have a financing contingency, and their mortgage application is rejected, they’d still be legally obligated to come up with the price of the home—a tall order for anyone who doesn’t have a few hundred thousand dollars lying around.
Most buyers start their home search with a mortgage preapproval letter in hand, and assume this letter means that a mortgage is a foregone conclusion. This isn’t the case — many preapproved buyers fail to gain ultimate mortgage approval. The fact is getting a mortgage is tough, and that’s why many buyers end up buying further reassurances like mortgage protection insurance, even after they’ve already got the loan secured.
The way most financing contingencies are written, the onus for action is put on the buyer. They have until a specific date to terminate the purchase agreement via the financing contingency. If they don’t, the contingency is automatically waived and the purchase agreement becomes binding, whether or not they’ve secured financing.
The appraisal contingency
Financing is tied to the appraisal, which is why most purchase agreements include an appraisal contingency.
If the home is appraised at below the sale price, the lender may only approve a loan at the actual appraised value, which means the buyer would have to come up with the difference out of pocket. If they don’t have the money, the appraisal contingency allows them to walk away from the sale.
Appraisal contingencies may allow the seller to lower the sale price to the appraised value, or let the buyer go ahead with the sale, even if there’s a large disconnect between the appraised value and the sale price.
The home sale contingency
Many buyers need to sell their current home to be able to buy their next home, and this contingency gives them a window to do that—or walk away from the sale.
This contingency gives the buyer a specific amount of time to close on the sale of their current home and buy their new one. If they can’t close within that time frame, or if their current home doesn’t sell for enough to afford their new home, the would-be buyer can back out without any legal or financial consequences.
This is one of the more stressful contingencies for sellers, since they’re essentially waiting on the buyer, and may have to pass up other offers in the meantime. In a hot market, sellers may reject a home sale contingency as too complicated and uncertain.
The kick-out clause
This clause gives sellers some protection against the uncertainty of a home sale contingency. Basically, it allows sellers to keep their home on the market and entertain other offers while the buyer’s home sale contingency plays out.
If the seller receives a better, non-contingent offer, they’ll usually give the buyer a chance to continue with the sale, but with a waived home sale contingency. If the buyer can’t or won’t agree to waive their home sale contingency, the seller can go with the new buyer.
Article last modified on May 9, 2022. Published by Debt.com, LLC