When interested in purchasing a home, to show the seller you are a qualified buyer and have access to funding, buyers typically submit a formal offer contract. An offer contract on a house often includes basic information about the buyer, seller, and property, the purchase price, an earnest money deposit, and proof of funding. These are meant to make the seller feel good about the transaction. To put the buyer’s mind at ease, it is common to include contingencies, or conditions that must be met in order for the deal to go through.
Essentially, the way a contingency clause works is the buyer agrees to purchase the property ONLY if contingency clauses are met. Typically, a buyer can get out of the contract before the closing date and only lose their earnest money. The earnest money gives the seller peace of mind about all the possible contingencies. Compared to other purchases, real estate transactions are large scale. Contingency clauses can protect both the buyer and seller and even the mortgage lender.
Here are some common real estate contingencies you might find in a purchase agreement, particularly for investment properties:
A title contingency gives the buyer an out if the title comes back with issues. When purchasing an investment property, in particular, title issues can occur. Most real estate investors will perform a title search or hire a title company to investigate. In the unusual occurrence that the title wouldn't be clear, and therefore the buyer might not be the rightful owner to the property, the buyer is obviously going to want to get out of the contract. The buyer would likely lose their earnest money deposit, yet not be stuck in the real estate contract. Some examples of title issues are a past ownership dispute or a broken chain of title.
Home Inspection Contingency:
Often buyers put in offers on a home before taking the time to do a full home inspection. Once the offer is accepted, the real estate contract goes into effect. This can be risky if you don't know what you are getting into. A home inspection contingency will provide the buyer with a short amount of time (inspection contingency period) to perform a home inspection and negotiate any repairs or even the sales price. Minor repairs can be fixed by the homeowner before closing, but if there is something in the inspection the buyer is unhappy with, an inspection contingency protects them with an out. For example. if the home inspection says the roof and HVAC system need to be replaced immediately, the buyer can either further negotiate or use the inspection contingency to leave the agreement. This would be risking losing the earnest money, but otherwise the buyer would be out of the real estate contract.
Mortgage Financing Contingency
A financing contingency gives the buyer an out if they are unable to obtain financing. Although most buyers get pre-approved for loans before putting in home offers, sometimes the loan can fall through. If the buyer's financing falls through, they certainly will not be able to purchase the house. In this case a mortgage contingency is essential to protect the buyer
An appraisal contingency gives the buyer an out if the appraised value of the home comes back higher than the purchase price. As an example, let's say the buyer agrees in the purchase agreement to purchase a home for $500,000, but the appraisal comes back at $450,000. Most lenders will only lend on the appraised value, so in this example the buyer would have to cover the difference of the $50,000 on the purchase price in addition to their down payment. If the buyer cannot afford that, the appraisal contingency will allow them to leave the purchase contract.
Home Insurance Contingency
This contingency clause is typically requested by the mortgage lender, and states that if a buyer is unable to obtain homeowner's insurance they can get out of the contract without financial or legal consequences. Most lenders will not loan money on real estate property without insurance.
As we stated earlier, in real estate transactions there are many processes in place, such as contingency clauses and escrow, to provide both the buyer and seller with the most security possible. The amount of house sale contingencies buyers include in real estate contracts is very market dependent. In a buyer's market, there will be ample agreed upon contingencies. However, in a competitive market, many buyers will waive contingencies in order to win the purchase agreement. Another example of when contingencies are more prevalent is when you are buying a distressed property and using the BRRRR Method. Distressed properties are riskier than new construction. When preparing your real estate contract, we recommend working with a real estate attorney or real estate agent to ensure you have the proper contingencies in place.