Real estate transactions involve hundreds of thousands of dollars in addition to time and energy, meaning those who participate in the real estate market want to ensure they get the most value for their purchase or sale. Once a buyer places an offer for a home, and the seller accepts, they still must endure several steps to close the transaction. When the seller accepts the offer, the home moves to a contingent status, and both the seller and buyer may have to abide by contingencies to move the sale forward.
While most homes move through the pending status and close, some transactions do not finalize due to failure to comply with contingencies. This article will discuss the role contingencies play in the closing process, along with the most common types of contingencies that buyers and sellers should prepare for before they enter a real estate transaction.
What is a Contingency?
In real estate, a contingency is a condition that must be fulfilled for a sale to finalize. In other words, the sale is contingent on the completion of clearly defined events, otherwise, a party can void the contract, and the transaction does not progress.
There are several types of contingencies that both buyers and sellers can request of the other party. While some contingencies are more common than others, such as a home inspection or financing contingency, some do not often come into play except in particular circumstances. A contingency for buyers will look different than one for sellers, as each side must meet its end of the bargain.
When Do Buyers and Sellers Disclose their Contingencies?
A buyer will disclose their contingencies when they submit their formal offer for the property. If the seller decides to accept the offer, they may still negotiate with the buyer and disclose their contingencies as well. When both parties agree to the offer that includes each side’s contingencies, the sale progresses into the closing stage. The buyers will submit their earnest money deposit before moving forward.
Both buyers and sellers will naturally consult with their real estate agent during the offer and negotiation process to ensure the transaction meets their needs. Buyers should consider what they must do to fully close on the home, and sellers should consider how they can guarantee that the buyer will follow through on their offer.
Common Real Estate Contingencies
Both the buyer and the seller can potentially add contingencies to an underlying real estate contract. However, the seller initiates most contingencies to ensure the buyer moves forward with the agreed-upon terms.
Some of the most common contingencies include:
Financing Contingency
A financing contingency, also referred to as a mortgage contingency, gives the buyer time to secure their mortgage so they can finance their purchase. The contingency typically has a timeline and a buyer can request an extension if it takes longer to secure the financing. If the buyer cannot secure a mortgage before the deadline, the contract becomes void and buyers can recoup their earnest money deposit.
Buyers should receive a pre-approval prior to the home searching process, so they know how much they qualify for on a mortgage. It’s important to note that pre-approval does not guarantee that they will be able to secure a mortgage.
Inspection Contingency
A buyer should take every precaution to guarantee they receive a home that is in proper condition. Buyers can include a home inspection contingency that states that the sale will only move forward once the property passes the inspection. If the home inspection presents significant problems, the buyers can request that the seller bring the home up to par before moving forward with closing.
Buyers and sellers can negotiate who pays for the home inspection, which wraps into the closing costs. In a busy seller’s market, buyers may waive their home inspection contingency to receive an approval on their offer. This gamble can become risky, especially with older properties. Buyers should therefore exercise caution if they decide to waive the home inspection contingency.
Homeowners Insurance Contingency
While most mortgage lenders and states require that homebuyers acquire a homeowner’s insurance policy, residential real estate contracts may include an insurance contingency as well. The contingency states that the buyer must purchase a policy to move forward with the transaction.
There are several different types of insurance policies, but buyers may want to consider adding additional policies, like flood insurance, if they live in at-risk areas.
House Sale Contingency
If a buyer currently owns one home and needs to sell that home to finance the purchase of the new property, they may include a house sale contingency that gives them a fixed period of time to complete their sale. Buyers typically include this contingency so they can use the profit from the sale of their home to offset part of the cost of their new home.
First-time homebuyers will not need this type of contingency as they will not have another property to sell. To help finance their purchase, they can apply for first-time homebuyer programs.
Title Contingency
A title contingency protects the buyer if the owners cannot prove their current ownership. Liens on the property can also fall under a failure to comply with the title contingency. In the case the that the seller cannot fulfill the title contingency, the buyers can walk away and recoup their earnest money.
Kick-Out Contingency
A kick-out contingency adds an extra layer of protection for a home seller by stating that if the seller receives a second offer without contingencies, they can kick-out the first buyer and void their contingent contract. A buyer may want to include this contingency in an offer if they need to sell their property during a slow buyer’s market, or if they need time to acquire financing. This contingency shows the seller that they acknowledge the current market conditions and do not want to waste the seller’s time if the sale falls through.
Sellers who accept an offer with a kick-out contingency can continue showing their home while the potential buyer attempts to sell their home or acquire financing. This type of contingency is less common in a seller’s market.
Appraisal Contingency
This contingency protects the buyer and states that the sale only moves forward after an appraiser submits a fair market value for the property that matches the sales price. If the appraisal comes back with a lower value than the asking price, the buyers can ask the seller to lower their asking price. Should the seller not agree to lower their price, the buyer can then walk away from the sale and recoup their earnest money.
Real Estate Contingencies Best Practices
When creating a contingency, whether as a buyer or as a seller, it will be important to be as specific as possible. A vague condition gives leeway for a lawsuit down the line. Buyers and seller should consult with their real estate professional during this process to ensure they disclose a thorough contingency. Contingencies should also define clear deadlines and timeframes.
The contingency should also include a specific event and condition. A vague contingency might say the seller needs to “leave the property in good shape,” but a specific contingency would say, “the property needs to have no mold, pests, or other problems revealed during the inspection.”
Lastly, the contingency should be unambiguously binding. The contingency itself is not just a simple “to-do” list for the buyer and seller. Rather, it is a legal declaration that if one party fails to fulfill its responsibilities, the other will have the right to walk away from the deal.
What Happens When a Contingency Isn’t Fulfilled?
Each contingency should clearly outline what happens if the other party does not fulfill the contingency. In some cases, failure to fulfill the contingency will automatically void the contract, meaning that if parties still wish to complete the sale, they will need to start over.
In other situations, the failure to fulfill the contingency could give one party the right to void the contract but not necessarily the obligation. For example, if the buyer has not been able to secure financing, the seller might be willing to extend the deadline without voiding the contract.
Conclusion
Contingencies play an important role in residential real estate as they protect both buyers and sellers. It is essential that each party carefully craft their contingencies and ensure they understand the other parties’ terms before progressing with a real estate transaction.
