What are Contingencies in Real Estate?

When working on a computer, the “undo” button offers a sense of security, allowing one to reverse actions when needed. In real estate transactions, contingency clauses play a similar role, providing a safeguard for buyers and sellers when certain conditions aren’t fulfilled. These clauses allow either party to back out of a real estate deal if specific criteria aren’t met. Typical contingencies in real estate include appraisal, inspection, sale, or funding contingencies.

Understanding Real Estate Contingencies

In the real estate world, a contingency is a clause included in a purchase agreement that outlines specific conditions or actions that must be fulfilled for the contract to become legally binding. Both the buyer and seller need to agree to these terms and sign the contract for it to take effect.

The presence of a contingency clause provides a level of flexibility to both parties. It serves as a safeguard, allowing either the buyer or seller to withdraw from the agreement without facing penalties if these conditions aren’t satisfied. This safety net is crucial in real estate, as it ensures that neither party is locked into a deal that isn’t going as planned.

A practical example of this is when a transaction depends on other real estate deals. For instance, a home seller might accept an offer that’s contingent on their ability to find a new home. If they can’t find a suitable home within a set time frame, they have the right to cancel the deal without any penalties, provided this contingency is clearly stated in the contract.

Contingencies vs. Contingent Listings

It’s easy to mix up “contingencies” with “contingent listings,” but they’re not the same. A contingent listing refers to a home that’s currently on the market and has an accepted offer but isn’t officially sold yet. This means the sale is still subject to certain contingencies that need to be resolved before the transaction can be finalized. In contrast, contingencies themselves are the specific conditions that must be met to move forward with the deal.

By understanding these clauses and how they function, buyers and sellers can navigate real estate transactions with more confidence and protection, ensuring that they aren’t locked into deals that may not work out as expected.

6 Common Contingencies in Real Estate Contracts

When navigating real estate transactions, it’s essential to understand the various contingencies that can be included in a contract. These clauses help protect both buyers and sellers, ensuring that certain conditions are met before finalizing a sale. Here are six of the most frequently encountered contingencies:

1. Mortgage Contingency

The mortgage contingency specifies a set period during which the buyer must secure financing for the home purchase. If the buyer cannot obtain a mortgage loan within this timeframe, they have the option to withdraw from the deal without facing any penalties. In such a case, the seller is then free to re-list their home and seek a new buyer. This clause ensures that buyers aren’t obligated to complete the purchase if their financing falls through.

2. Title Contingency

This contingency grants the buyer the right to conduct a title search on the property and raise any concerns about the title’s status. If any issues or defects are discovered, the seller is required to resolve them before the transfer of title can proceed. This process helps ensure that the buyer receives a clear and undisputed ownership of the property. It provides an essential layer of protection, ensuring that no legal or financial claims against the property hinder the transaction. Title insurance is also recommended as a fail safe against future issues.

3. Home Inspection Contingency

The home inspection contingency gives the buyer a specific window of time to have the property professionally inspected. This inspection helps identify any significant issues, such as structural damage, roofing problems, or faulty electrical systems. If the inspection reveals any defects and the seller chooses not to address or repair these issues, the buyer has the right to terminate the contract. This clause is crucial for buyers who want to avoid unexpected repair costs after moving in.

4. Sale of a Prior Home Contingency

This contingency is designed to protect buyers who need the proceeds from selling their current home to finance the new purchase. If the buyer is unable to sell their existing home within the time specified in the contract, they can back out of the real estate deal without penalty. In some situations, if a traditional buyer isn’t found in time, a “power buyer” or iBuyer might step in to make a quick offer, allowing the transaction to proceed smoothly. While iBuying has slowed down in certain areas, it remains a viable option in many active markets.

5. Appraisal Contingency

The appraisal contingency protects the buyer by requiring that the property appraises at or above the agreed-upon sales price. If the appraisal value comes in lower than expected, the buyer can cancel the contract. Alternatively, the seller may choose to lower the sale price to match the appraised value. This clause is crucial because lenders typically won’t finance a property for more than its appraised worth, ensuring that the buyer doesn’t overpay.

6. Homeowners Insurance Contingency

This clause requires the buyer to apply for and obtain homeowners insurance for the property. If they are unable to secure the necessary insurance, either the buyer or seller can choose to withdraw from the contract. This contingency is often requested by the mortgage lender or seller, as having proper insurance is essential for protecting the property from potential risks.

These six common contingencies play a vital role in real estate transactions, offering protections that help both buyers and sellers navigate the process more smoothly and with greater confidence. Understanding them can make all the difference in ensuring a successful and stress-free property deal.

What Happens If a Contingency Isn’t Met?

When a contingency condition fails to be met in a real estate transaction, either party involved can treat the contract as null and void. This means that both the buyer and seller have the option to cancel the deal and move on to other opportunities.

For instance, if a property doesn’t appraise at the expected value, this can jeopardize the financing required for the purchase. In such cases, the buyer and seller can either decide to cancel the agreement, challenge the appraisal, or renegotiate the purchase price to reflect the lower appraised value. These options provide a chance for both parties to suggest compromises and potentially keep the deal alive.

Similarly, if a buyer is unable to secure the mortgage loan needed to complete the purchase, they typically have the right to terminate the transaction. However, the buyer and seller may mutually agree to extend the timeframe, allowing the buyer more time to explore other financing options.

The Connection Between Contingencies and Earnest Money

Contingencies also play a significant role in determining the fate of the earnest money, which is a “good faith deposit” made by the buyer when entering into a contract to purchase a home. If a contingency isn’t fulfilled, the buyer usually has the right to have their earnest money returned.

This earnest money is typically held in escrow by a third party until the deal is finalized. If the buyer fails to meet the terms of the real estate contract without a valid contingency, the seller gets to keep the earnest money as compensation. However, if the buyer includes specific contingencies that allow them to legally exit the contract, they can reclaim their earnest money. This setup provides an “emergency escape hatch” for buyers, ensuring they’re not financially penalized when unforeseen issues arise.

Essential Contingencies Homebuyers Should Always Include

In the past, the real estate market was so competitive that many buyers waived contingencies in an effort to win bidding wars. However, as the market has cooled, buyers now have more room to include these protective clauses in their contracts.

Under normal circumstances, buyers should always have a financing contingency in their purchase agreement. This is a standard requirement in nearly all states and ensures that if a mortgage is denied for any reason, including a low appraisal, the buyer can recover their deposit money. This clause is especially crucial given recent declines in home prices across the country.

Another important contingency is the appraisal contingency, which protects buyers if the property appraises for less than the agreed-upon price. This contingency ensures that buyers don’t overpay for a property and provides an opportunity to renegotiate the deal if necessary.

It’s also wise to include a homeowners insurance contingency, even if your lender doesn’t specifically require it. This ensures that the buyer can obtain adequate insurance for the property, which is crucial for protecting against potential damages or losses.

For buyers who need to sell their existing home before purchasing a new one, a sale of a prior home contingency is vital. This clause allows them to back out of the contract if they can’t sell their current home in time, reducing stress for all parties involved.

Lastly, it’s essential to include a title contingency. This ensures that the property being purchased is free of any liens or legal issues and is being sold by the rightful owner. A title contingency safeguards buyers by ensuring they acquire a property with a clear, marketable title without any hidden defects that could cause problems later.

By incorporating these contingencies into a real estate contract, buyers can protect themselves from unexpected setbacks and navigate the home-buying process with greater confidence and security.

Be Cautious — Especially in a Seller’s Market

While contingencies provide essential legal protections, buyers should exercise caution about overloading their contract with too many of them, particularly in a strong seller’s market. In such markets, sellers often have multiple offers to choose from, making them less willing to deal with contracts packed with contingencies. This can make a buyer’s offer appear less competitive. Buyers who are flexible, avoid making too many special requests, or are even willing to waive certain contingencies may stand out to sellers who have the upper hand in negotiations.

Sellers, on the other hand, should be mindful not to harm their own negotiating position by including unnecessary contingencies. Often, sellers become so eager about the prospect of selling their home that they might end up undervaluing their position by agreeing to contingencies that aren’t in their best interest. One effective strategy for sellers is to include an “as-is” clause in the contract. This approach allows them to sell the property without being obligated to make repairs or provide closing credits once the deal reaches the closing date, thereby simplifying the process and protecting their position.

Working With a Trusted Agent

Deciding which contingencies to include in a contract, as well as the specific terms for each, requires careful thought. This is where the expertise of a seasoned real estate agent or attorney becomes invaluable. A knowledgeable agent can help guide you through the complexities of real estate negotiations, ensuring that you make informed decisions and maintain a strong bargaining position. They can also assist in creating a fallback plan, ensuring you’re prepared in case your real estate deal doesn’t close.

By partnering with an experienced agent, both buyers and sellers can navigate the intricacies of contingencies with greater confidence, ensuring that they are protected while also maximizing their chances of success in the transaction.