Contingencies -What are They and Why Do I Need Them?
What is a contingency and what does it mean for me when I am buying a house?
Contingencies protect you as the buyer and ensure certain conditions are met before finalizing the purchase. If you terminate the contract during and because of a contingency time period, you can get your Earnest Money back and are not in default of the contract.
Here are some common contingencies when making an offer on a house:
Due Diligence - We negotiate how long this period is when we make the offer. About 7 days is fairly common in the current market. This allows you to have a professional inspect the home for any hidden issues (e.g., structural problems, plumbing, electrical systems, etc.). If significant problems are found, you can request repairs, negotiate a lower price, or cancel the contract without losing your earnest money. This is also the time you may want to do specific environmental tests, such as radon testing or check out the well if there is one. During due diligence you also need to do any other checks of the area to make sure you are comfortable with where you are buying. Is a construction project starting nearby that could affect your quality of life? Are there any known sex offenders nearby? Does the HOA allow what you want to do with the property? Different things are important to different buyers, so make sure to explore anything that is important to you.
Financing Contingency (Mortgage Contingency) - This is one of the most common contingencies. It means the offer is contingent on you being able to secure financing (a mortgage loan). If you can't get approved for a loan, you can back out of the deal without penalty as long as it is determined during the timeframe in the contingency. Currently this is typically around 21 days but sometimes less if you are doing a quicker close.
Appraisal Contingency - This protects you if the property’s appraisal comes in lower than the agreed-upon sale price. If the home is appraised for less than the sale price, you can renegotiate with the seller or back out of the deal, potentially without losing your deposit. This is most often part of the financing contingency but it is an option for a cash deal as well.
Sale of Current Home Contingency - If you need to sell your current home in order to buy the new one, you might include a contingency stating that the sale of your existing home must occur before you can proceed with buying the new property. This protects you from owning two homes at once if the buyer for your current home backs out or if you can’t get a contract on your home. Sale of current home contingencies are becoming more common and I have helped both buyers and sellers navigate these. Typically there is something called a Kick-Out clause which protects the seller from having their home unavailable for sale for a prolonged period. If the seller receives another offer they are willing to accept, then they give the current buyer a day or two (previously negotiated timeframe) to either remove the contingency or terminate the contract (and keep their Earnest Money). I tell my buyers that although buying a home with this contingency is a great way to protect themselves when they have to sell their home to buy their next home, it does unfortunately lower your negotiating power. You also risk paying for an inspection and an appraisal and then get “kicked out” of the contract. Ideally, you will have a Plan B to buy the home if the seller invokes the Kick-Out clause. I’ve had clients temporarily dip into their retirement accounts or ask a family member for some help to bridge the short gap between selling and buying their next home.
Contingencies are a great way to help mitigate the potential risk of buying a home. Each contingency listed above helps protect you from hidden problems or risks that might arise after you make the purchase. They also allow time to explore your financial ability to make sure you can afford the home you want to buy. For those reasons it's important to carefully review, understand, and negotiate contingencies to suit your needs and the specifics of the home you're buying. As always, I’m here to guide you through the process!
