Contract Contingencies That Protect Homebuyers
What happens after my offer to purchase is accepted and my earnest money deposit is secured? Is my contract binding? Can I back out if something arises that I don’t like? In short, your real estate contract is binding but there are certain contract contingencies in place that protect buyers from certain unforeseen issues that may arise.
What are real estate contract contingencies?
A contingency clause is a contract provision that requires a specific event or action to take place in order for the contract to be considered valid. If the party that's required to satisfy the contingency clause is unable to do so, the other party is released from its obligations. In a real estate transaction, there are 2 types of contingencies: those that protect the seller and those that protect the buyer. In this article we are going to cover contract contingencies that protect the buyer of a home from losing their earnest money deposit after the offer has been accepted and the home is under contract.
*Earnest money depost or EMD is the sum of money you put into escrow that represents your seriousness to go through with the purchase of a home.
Basically, there are 2 types of buyer contingencies to a real estate contract. There are those that are standard or inherent in every standard real estate contract and those that must be requested by the buyer in the offer. To keep things simple, I will refer to them as Teir 1 and Teir 2 respectively.
Teir 1 Buyer Contingencies:
These contingencies are standard in every real estate contract and the timeframes for inspections, requests and walk-away windows are specified. Keep in mind, it is possible to extend said timeframes if both the buyer and seller agree.
- Inspection contingency-radon, termite, home inspection
- Financing contingency
- Appraisal contingency
- Title contingency
- Final walkthrough contingency
Teir 2 Buyer Contingencies:
These Contingencies must be included by the buyer in their offer to purchase. The terms and conditions must be explicitly stated and agreed upon by both parties.
- Home sale contingency
- Special contingencies
Inspection contingencies refer to the buyer’s right to inspect the property for radon gas, wood-boring insects, and defects found in the home inspection. If any defects or problems arise, the buyer retains the right to request repairs or back out of the contract altogether. In short, the buyer has 14 calendar days after the attorney review period is completed to complete all inspections and furnish the seller with those reports as well as a written request for repairs or of their intent to withdraw from the contract.
In a seller’s market it can be tempting to waive your right to inspections in order to make your offer more attractive. This is never advisable. All types of unforeseen problems can be uncovered during the inspections that may make the property uninhabitable or at the very least unacceptable to you, the buyer. In my career, I have seen all types of issues and defects arise during the inspections including: radon gas, termites, leaking roofs, cracked foundations, defective utilities, and more. In one instance where I represented the seller of a transaction, the inspection report uncovered a vertical crack in the foundation of a seemingly perfect home. The cost to cure was $30,000. Much to the dismay of my seller, the buyer chose to back out of the contract. The point is that the inspection contingency is there to protect you, and you should almost always use it.
As you may or may not know, the mortgage prequalification is not a mortgage approval and there is no guarantee that you will obtain one. After your offer is accepted the loan must go through the underwriting process for mortgage approval. It is here where some buyers can run into trouble. There are several things that can happen that result in the buyer not being able to obtain mortgage approval even after they have been preapproved. A prior bankruptcy can be uncovered, a buyer’s credit situation could change, issues with your financials, etc. The financing contingency is there to protect the buyer in the event the mortgage cannot be approved due to any of these reasons to ensure you don’t lose your EMD deposit.
The appraisal contingency is closely related to the financing contingency as it is one the conditions to achieve mortgage approval. Basically, this contingency protects the buyer if the home they wish to purchase does not appraise. But what does this mean?
For example, let’s say your offer to purchase a home for $300,000 and your offer is accepted by the seller. The seller agrees to all home inspection repair requests and now you are waiting for the appraisal from your lender. The appraisal comes back at $280,000. This presents a potential problem because the lender will only agree to issue a loan equal to or lower than the appraised market value of the property. However, there are some options. In this scenario, there is a $20,000 difference between the purchase price and the appraised value. Firstly, the buyer could agree to make up the difference themselves by paying an additional $20,000 at closing. Second, the sellers might agree to lower the purchase price to the appraised value of $280,000 in order to satisfy the condition of the loan. Alternatively, both parties could come to some agreement that is a combination of both. This is the most common strategy. In this scenario, the seller may agree to lower the purchase price to $290,000 and the buyer would pay an additional $10,000 at closing to satisfy the loan. Thus, both parties have agreed to meet in the middle. If no agreement can be made, the contingency allows the buyer the right to back out of the contract without losing their EMD.
In a real estate contract, the title represents ownership, and the title search can reveal any other owners or liens against the property that you were initially unaware of. The title search could reveal that the seller of the property does not in fact have absolute right to sell the property because the home is jointly owned with another party. The other owner would have to be included in the sale in order to satisfy this issue. Alternatively, the title search may reveal that there are unpaid taxes and tax liens against the property that would transfer to the new owner. These taxes would have to be paid for clear title to be issued. Basically, the title contingency protects the buyer from these types of unforeseen situations and allows you to back out if clear title can not be issued.
Final Walkthrough Contingency:
This contingency is fairly straight forward. The final walkthrough is usually completed the day of closing to make sure that everything that was agreed upon was completed and there are no surprises to the buyer prior to closing on the home. Let’s say the buyers agreed to repair a bath faucet that was found not to work during the home inspection. During the final walkthrough the buyers tested the faucet and determined it was still not working. Now, an arrangement must be made to either extend closing to allow the repair, credit the buyer for the repair, or the buyer could even walk away from the contract.
Home Sale Contingencies:
The home sale contingency is the most common type of contingency that a buyer might add to the offer to purchase. In short, this means that the buyer must sell their current home first in order to close on the house they wish to purchase. More information on the details of this type of offer can be found in another blog post I wrote here. Ideally, you would want your house to be under contract before submitting this type of offer. Your offer would be contingent upon your home for sale closing on a specified date in order for your purchase contract to move forward to settlement. The home sale contingency protects the buyer in the even that the contract on their current home falls through for any reason. In which case, the EMD would be returned to the buyer.
Special contingencies refer to any other condition the buyer may wish to include in the offer to purchase. For example, the buyer may request the above ground pool must be removed before closing or a certain room in the house be painted. Basically, a buyer can include in his offer any condition be met before closing. If accepted by the seller and not completed, the buyer would retain the right to back out of the contract and their EMD returned.
The Bottom Line:
The bottom line is that real estate contracts, while binding, were designed to protect the buyer. Most contingencies are already included in every real estate contract and others must specifically be requested and agreed upon. It is important not only to utilize these contingencies, but also to be aware of the terms and timeframes attached to each contingency to protect yourself as you navigate the transaction to purchase your new home.