What is a Contingency?
Think of the word "contingency" as akin to "if." When a homebuyer
signs a contract agreeing to the purchase of a home, she is saying, "I
agree to purchase this home for this amount of money if …" The "if" is
the contingency.Contingencies are those items that must come to pass before the sale finalizes. The list of possible contingencies is endless – you could tell a seller that you'll purchase his home if his dog turns into a pig, sprouts wings and flies away. You could do that, although you probably wouldn't get the house.
Contingencies in a real estate contract also represent steps along the way that allow the buyer to back out of the deal without losing her earnest money deposit or incurring a lawsuit.
Contingencies may be scattered throughout a contract. Let's take a look at some of the more common real estate contract contingencies.
Loan Approval
This is generally the first contingency listed in the contract. For instance, in the California Association of Realtors® Residential Purchase Agreement, it is on page 2, paragraph H(2).
It begins by stating that the buyer must act "diligently and in good faith" to obtain the loan described on the previous page. "Obtaining the loan(s) specified above is a contingency of this Agreement unless otherwise agreed in writing."
This particular contract goes on to mention that obtaining and providing a deposit, and payment of the down payment and closing costs, are not considered contingencies, but buyer obligations. At the end of this clause is a standard 17-day time period to remove this contingency, but the buyer is free to shorten or lengthen this time period in a space provided on the form.
The loan approval contingency is one that the seller's agent will scrutinize when first going over your offer, and for good reason. The seller will be removing his home from the market if he accepts your offer and taking a chance that your loan will come through. The longer you take to get loan approval, the longer his home is off the market. If you end up being denied the loan, the seller has lost valuable marketing time.
Most contingencies work this way: Even if the contract states a time period, the buyer can choose a time frame that is more to her liking and hope the seller is OK with it.
Home Inspection
The home inspection offers the buyer an opportunity to determine, through the help of a professional, if there is anything wrong with the home's structure and major systems. It is a visual inspection only, so don't plan on finding out if there's something brewing behind the walls.
Most inspection contingencies state that you have the right to back out of the contract if the results of the inspection aren't satisfactory. Others may state that you can back out if the seller refuses to remedy any problems. Decide ahead of time how you want your inspection contingency worded.
If the inspection turns up items in need of replacement or repair, you can ask the seller to fix the problems, to deduct the cost of the repairs from the price of the house, to credit you back the money to fix them (if the lender allows this) or you can walk away from the purchase and receive your earnest money deposit back.
In some parts of the country, other inspections are customary, such as wood-destroying pest inspections in California and subsurface sewage treatment system and well inspections in Minnesota. Each of these represents a contingency.
Sale of the Buyer's Property
It's often an immense juggling act to sell one house before you close on another. In these cases, buyers frequently make the purchase of the new home contingent on the successful sale of their current home.
Whether a seller will accept an offer with this contingency depends on a number of factors. In a seller's market this contingency is typically rejected. When there are few buyers competing for homes, however, sellers are more motivated to accept less-than-ideal offers.
The seller's personal situation may play into his decision as well. If he needs to sell his home quickly, he may reject your offer, or counter it, asking for the contingency to be removed from the offer.
Inspection of HOA Documents
If the property you hope to purchase is in a community with a homeowners association, you will be provided with a mountain of documents. These include, but aren't limited to:
Covenants, Conditions and Restrictions (CC&Rs) - These include pet policies, parking rules, rules for the use of on-site amenities, exterior décor, landscaping restrictions and more.
The HOA Budget - This includes important information about where the money goes and whether the reserve account contains enough money to meet emergencies.
HOA Board Meeting Minutes - The meeting minutes will let you take a peek behind the scenes and find out what type of issues the board generally deals with, what actions they have taken against homeowners, and if there has been any discussion about raising fees or levying special assessments.
Governing Documents - Sometimes called bylaws, these documents let you know how elections are run, how a homeowner can go about getting a seat on the board, and the length of each member's term.
You'll need the time to read through each document carefully, especially to determine if there is any pending litigation against the HOA or the developer. If there is, your lender may deny the loan.
Ensure that you are provided adequate time to either read the paperwork yourself or have your lawyer go over it.
Appraisal Contingency
Unless you are paying cash for the home, the appraisal contingency is second in importance only to the loan approval contingency. The appraised value of the home represents the maximum amount of money the lender will give you. If the lender's appraiser determines that the home isn't worth what you've agreed to pay for it, you have several options:
Ask the seller to lower the home's price to the appraised value.
Increase the amount of your down payment to reduce the loan amount.
A combination of the first two; the seller reduces the price and you add more cash to meet the appraised amount.
Ask for a new appraisal. This only works if the appraiser made mistakes or if you or the seller can add information that the appraiser didn't take into account.
Walk away from the purchase.
Your real estate agent is your best source of information on the various contingencies in a real estate contract. Follow your agent's advice about staying on task during the process so that you can formally remove the contingencies by the dates specified.
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