The provisions of a contingency contract in real estate are there to help buyers and sellers alike. For investors, the inclusion of contingencies is a good way to keep out of a bad situation with a real estate contract. These ancillary clauses enable investors to not only acquire properties on their terms, but provide a way out if things go south. Because a real estate contract is a binding agreement, it is imperative for investors to understand contingencies, how they’re used, and explore the many variations available.
What Is A Contingency Contract In Real Estate?
According to Investopedia.com, a contingency contract in real estate is a “condition or action that must be met for a real estate contract to become binding.” Real estate contingencies are meant to safeguard investors, but they can also work as a double-edged sword. While these stipulations may further protect investors from mistakes, they can also have a negative effect on the negotiation process. The overuse of contingencies can overwhelm sellers in some cases and ultimately have an adverse impact on the completion of a deal.
Because every real estate deal is different, it’s critical for investors to understand how to adequately incorporate contingencies. The number of contingencies investors use will vary from deal to deal and property to property; the right combination will depend on both the type of deal and the fine print, as well as all parties involved.
Can You Make An Offer On A House That Is Pending?
You can make an offer on a house that is pending, although there is no guarantee that your offer will go anywhere. However, this should not discourage you. If a sale is pending, there is nothing stopping you from making a backup offer in case the current contract falls through. In addition, if the active contract has an existing real estate contingency, such as a kick-out clause, the chances of the contract falling through increases.
Most Purchase Agreements Are Contingent On Which Two Items?
The inspection and financing contingencies are the two most important contingencies home buyers should care most about. No home buyer wants to close on a transaction only to find hidden defects three months down the line. This is why including an inspection contingency in the purchase agreement is a must. The financing contingency is also important because it states the closing timeline. This protects the buyer because if for whatever reason they are unable to acquire the necessary funds, they will still be able to receive a full refund on their earnest money deposit.
There are of course a number of other contingencies that exist to help protect both the buyer and seller in any real estate transaction (which you can read on to learn more about) but in terms of the purchase agreement, including both an inspection and financing contingency will ensure a smooth deal.
8 Must-Have Real Estate Purchase Agreement Contingencies
Appraisal Contingency: The appraisal contingency is used when the buyer wants to make sure that the property is valued at at least the specified amount.
Financing Contingency: Also referred to as a mortgage contingency, the buyer can gain more time to obtain financing in order to purchase the property.
Home Inspection Contingency: This contingency provides the buyer with an opportunity to have the property inspected and negotiate the purchase price or repairs based on any findings.
Home Insurance Contingency: This contingency requires the home buyer to purchase a home insurance policy, and is sometimes added by the seller or a requirement from the lender.
Right To Assign Contingency: A right to assign contingency is especially useful for wholesale real estate investors, as it provides the option to back out if they are unable to assign the contract to another buyer in a timely manner.
House Sale Contingency: This contingency provides a period of time for the buyers to finalize the sale of their current property.
Kick-Out Clause: The kick-out clause helps to protect sellers when their buyers use a house sale contingency, allowing them to back out if they find a more qualified buyer.
Title Contingency: If there are any issues with the title, such as an ownership dispute or lien, this contingency allows buyers to walk away if the problem cannot be resolved before closing.
The mainstay of any real estate contract is the appraisal contingency. This stipulation essentially awards investors two options: back out of a deal if the appraisal price on a property is not as high as the purchase price, or renegotiate the purchase price with the ability to end the deal if they decline.
The appraisal of a property is typically performed by a professional and licensed appraiser. Their responsibilities are to estimate the value of the home and produce a written report with an appraised value attached. The amount of money a bank loans will be based on the appraisal value of the property. If the appraisal amount is lower than the home price, the buyer is responsible for coming up with the difference. For example, if a home appraisal comes in at $400,000 and the asking price is $500,000, the bank will only loan $400,000. In this case, the buyer would need to come up with an additional $100,000 to purchase the property.
Another common stipulation in a real estate contract is the financing contingency. This clause states the offer is contingent on your ability to obtain financing, and it will specify the type of financing, terms, and the amount of time in which you have to apply and be approved for the loan.
The financing contingency is important for many reasons. One of the biggest reasons is in the event your loan falls through at the last minute and you are unable to secure financing in time. This ruling will allow you to walk away from the deal without repercussions or loss of earnest deposit. Consequently, this contingency is another reason why sellers prefer to do business with all-cash buyers.
Home Inspection Contingency
Far and away, the home inspection is one of the more important protection contingencies of a real estate contract. This period of due diligence, which will often range from three to 14 days, allows investors a period of time to conduct inspections on the property, including various walk-throughs, to ensure the property is up to their buying standards. A home inspection will provide the buyer will a detailed report of the property, as well as an outline any repairs and future issues that may arise.
A typical home inspection will cover the following:
Pest and termites
Heating and air conditioning
Easements and encroachments
Foundation and basement
Sewer or septic system
Trees and vegetation
Water systems and plumbing
Radon or methane gas
Permits and zoning
As an investor, you have three options with the home inspection contingency: Ask for a discount to help with any necessary repairs, accept the offer and make the repairs, or back out of the deal based on the findings of the home inspection report.
Home Insurance Contingency
Another crucial contingency to add in your real estate contract is home insurance. Lenders, and sometimes even the seller, will require buyers to apply for and obtain homeowner’s insurance. Furthermore, this condition will typically be added in the home sales transaction contract, with fulfillment of the conditions and requirements in the term completed during the escrow process.
The home insurance contingency seeks to protect a buyer’s new purchase from disasters such as property damage, fires, natural causes, and other issues. However, the act of obtaining insurance for a property — particularly in a specific region — may be harder than expected. Insurance companies have become more reluctant to insure properties in certain areas and regions of the country. In return, this gives buyers an option to back out of a deal in the event they are unable to secure insurance before closing.
Right To Assign Contingency
Lastly, a standard clause for real estate investors, specifically wholesalers, is the Right To Assign contingency. This stipulations provides investors with the option to back out of a deal if they are unable to assign the real estate contract to another buyer in an adequate timeframe. In most cases, a wholesale contract will include a legal document called the Assignment of Contract, which states you are assigning the rights as the buyer in the purchase agreement to another buyer. With the Right To Assign contingency, wholesalers are able to protect themselves in the event the buyer defaults.
House Sale Contingency
Timing can often throw a wrench into anything we do in life, and that includes buying and selling homes. In many cases, home buyers will often be trying to sell their current home while shopping for a new one. In such cases, a house sale contingency is a real estate contingency clause that can help protect the buyer. If the buyers are unable to sell their current home, or for at least the asking price, within the specific amount of time are able to back out of the deal without being penalized. This may be one of the most common real estate contingencies.
If you are a seller, you may be wondering what contract contingency might serve to protect you in case a buyer would like to implement a house sale contingency real estate contract. Luckily, the kick-out clause is one of the most helpful contingencies real estate can offer. While the contingency contract is in effect, the kick-out clause allows the seller to continue marketing the property. If the current buyer fails to remove the house sale contingency within the specified amount of time, the seller can back out of the contract and offer the property to another qualified buyer.
During the home buying process, a real estate attorney or title company will do a title search on the property. The title serves as a record of homeownership and is essential to the sale of the property. In most cases, any issues with the title can be resolved before the closing process. However, in some cases this situation could lead to a number of challenges for the potential new homeowners. A few examples include a lien on the property that must be paid before the sale, or perhaps an ownership dispute if the seller cannot legally prove they own the property. A title contingency protects potential owners from these situations by allowing them the opportunity to walk away if these issues are not resolved before closing.
The ability to anticipate potential problems with a real estate contingency contract comes down to having the insight to include contingencies from the get-go. While some believe eliminating these clauses will better enhance your chances of closing deals, it can also leave you (and your pocket book) high and dry when things go awry. Having a clear understanding of contingencies—including what’s typically used, as well as what’s not—will only better ensure your chances at scoring an excellent real estate deal.
Do you have experience dealing with a contingency contract? If so, how many contingencies do you think is too many? Which type of contingency do you think is the most helpful? Feel free to share your thoughts below: