Real estate investors and buyers need protection when entering a sales contract for hundreds of thousands of dollars.
Price comprises just one piece of the puzzle. Buyers and sellers must agree on all aspects of the transaction, and contingencies in real estate offers protect the buyer from ugly surprises.
If you’re looking for a valid way out of a contract before signing on the dotted line, learn how real estate contingencies leave you a way out of the contract without losing your earnest money deposit.
Real Estate Contingency Definition
A real estate contingency puts a condition on the sale of the property. The sale won’t occur until you or another party satisfies the necessary conditions. If the interested party doesn’t satisfy the condition, the buyer may back out of the sale without losing his or her earnest money.
Contingencies protect the investor from a bad investment, but add too many real estate offer contingencies and a seller may turn down your offer. Sellers won’t take their home off the market for a sale that might or might not go through. They want a “sure thing” – or as close to it as they can get.
Note that real estate offer contingencies don’t give buyers carte blanche permission to walk away from the contract. The real estate contingency definition allows the buyer to withdraw from the contract only for specific, legitimate reasons.
How do Real Estate Contract Contingencies Work?
Real estate contingencies add conditions outside of the normal terms of a contract. All contracts include the following:
- Sales price
- Terms of the sale as agreed
- Home address and description
- Closing date
- Earnest money deposit amount
The rest of the sometimes differs however. For example, if you think the home may have issues not visible to the naked eye, you may ask for an inspection contingency. You may back out of the sale if the inspection report reveals too many issues or the seller refuses to fix them.
If you have a prior house you must sell before you can afford to buy a new home, you may include a home sale contingency. If your home fails to sell, you can pull out of the contract without penalty.
Contingencies in real estate offers can appear within the sales contract itself, or can appear in a separate real estate contingency addendum.
Real Estate Contingency Rules for Success
Everything in life is negotiable, and nowhere is that truer than real estate contracts. So while true real estate contingency rules don’t exist, it still helps to follow certain guidelines.
Rule 1: Don’t overdo it.
Left to their own devices, buyers would want to include every contingency in the book. But much as they add security for buyers, they remove it for sellers. Think carefully about which contingencies add the most value to you personally before including them in a real estate sales contract. Which do you need to feel comfortable making an offer? Approach a seller with ten contingencies and you can expect them to balk. But the seller may accept one or two carefully conceived conditions.
Rule 2: Combine multiple contingencies into one.
Why include a financing contingency and an appraisal contingency? If the home doesn’t pass the appraisal, you can’t get financing. Instead, choose one contingency and let the others fall into place. Do your due diligence quickly during the contingency period. If there’s a reason the sale won’t work, exercise your contingency rights within the conditional period.
Rule 3: Don’t be afraid to use contingencies as bargaining chips.
Think of contingencies as one more element to negotiate. Use them wisely and they open doors for you. For example, say the home inspection reveals more issues than you expected. A contingency gives you a way out, but it also provides a chance to re-negotiate the sales price or other terms, such as a seller concession. You can also use real estate contract contingencies as you negotiate real estate deals in the first place, haggling over the price and other terms. Don’t think of contingencies only as escape clauses, but as one more chess piece on the board.
Common Real Estate Contingencies
Understanding common real estate contingencies helps you make informed decisions when buying a home or investment property. While no means an exhaustive list, the following include the most common sales contract contingencies.
If you can’t pay cash for the property – and let’s face it, most of us can’t – you need financing.
But even if you have a loan pre-approval, your financing can fall through at any time. The property may not appraise for the full purchase price, or the underwriting department may decide it doesn’t like one of your income sources, or your mortgage or investment property loan could collapse for any number of other reasons.
A financing contingency entitles you to a refund of your earnest money deposit if your financing falls through. If you can’t secure solid financing within the specified time period, you have a way out of the contract.
One other angle to consider here is owner financing. If your mortgage falls through, you can always approach the seller for owner financing!
Home Inspection Contingency
An home inspection provides more information about the property’s condition, beyond what you see during your walkthrough. Inspectors look at the home’s interior and exterior, including all mechanical systems. They write up an extensive report detailing the home’s condition. If you have an inspection contingency, you can back out of the contract if the inspector finds something wrong with the home.
The inspection contingency often prompts re-negotiations when the inspector finds any issues with the home. Buyers often negotiate a lower sales price or work the necessary repairs into the contract before backing out of the sales contract altogether.
The appraisal contingency gives you a way out of the contract if the home doesn’t appraise for as much as you offered. Mortgage lenders send a licensed appraiser comes to conduct the appraisal to determine the home’s fair market value. If comes in below what you offered, you can do one of three things:
- Walk away from the purchase, keeping your earnest money,
- Pay the difference between the sales price and the appraised value in cash, or
- Re-negotiate the sales price with the seller.
Lenders base their loan amount on the lower of the appraised value and the sales price, so the financing contingency can include an appraisal contingency embedded within it. Write your financing contingency to mention the property failing to appraise, and you can avoid spooking the seller with several real estate offer contingencies.
The title contingency coincides with the financing contingency too. Lenders won’t close on your loan if the title isn’t clear. The title history shows who has legally owned the property over the years, including the current owner and their ability to sell the property. It also records any liens or judgments held on the property that the seller must satisfy before selling the home.
If the title shows issues with homeownership and the risk of contested ownership arises, you may back out of the sale with a title contingency. Once again, consider embedding this into your financing contingency.
Home Sale Contingency
If you must sell a home you currently own in order to afford the home you’re buying, you probably need a home sale contingency. Life happens and sometimes the cards don’t fall in line. If you don’t find a buyer in time for the home you’re selling, you won’t be able to come up with a down payment for your new home.
The home sale contingency sets a deadline to sell your old home, as well as a minimum sales price. This way if you can’t sell the home by a specific date or for the price you wanted, you can back out of the real estate sales contract.
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Things to Know About Real Estate Contract Contingencies
First, all contingencies have deadlines. If you don’t exercise the real estate contract contingency within the allotted time, you can’t use it. For example, if you had a financing contingency that expires on 10/1, but you found out your financing fell through on 10/3, you lose your earnest money deposit. Pay close attention to the dates. If you need an extension, ask the seller. Letting the date pass means giving up your chance to back out with your earnest money in hand.
You also need to know your housing market. Buying in a buyer’s market gives you a proverbial leg up, negotiating from a position of strength. Having a few contingencies won’t usually cost you the deal in a buyer’s market. In a seller’s market, though, sellers have many more options. They typically choose buyers with few or no real estate offer contingencies.
Real estate contingencies must be specific. Vague, open-ended contingencies in real estate offers are hard to enforce. Your offer contingency must include dates and specific, measurable conditions that must occur.
Get all contingencies in writing. Don’t accept a verbal agreement for anything. Both the buyer and seller must agree on the contingency and include it in the contract of sale. Always run the conditions past your attorney, or at least your real estate agent, to make sure they adequately protect you and your deposit.
The real estate contract is a binding agreement. Anything included in the agreement is also bound by law, including contingencies in real estate offers. Remember, cancellations can go both ways. Sellers could back out too, potentially with your earnest money in hand.
Finally, note that sellers may accept other bids while the sale is pending. Until the contingencies expire, sellers can entertain other offers. They can’t “kick you out” of the sale unless they have a kick-out clause allowing them to accept a better offer, but the offers can wait patiently to see if you back out of the contract.
Before including real estate contingencies in your contract, look at the big picture. Look closely at supply and demand, and the competition for this property. If it’s a buyer’s market, use sales contract contingencies to your advantage. In a seller’s market, think carefully before proceeding.
Do you need the contingencies or are you trying to protect every possible scenario from occurring? Going overboard only hurts the situation and your chances of approval. Include the real estate offer contingencies that you need to protect your deposit, and leave out unnecessary contingencies to make your offer more competitive.♦
What real estate offer contingencies do you typically include in your contracts? How do you combine real estate contingencies to avoid spooking sellers?