Contingencies are a common occurrence in real estate transactions. They simply mean the sale and purchase of a house will only happen if certain conditions are met. The offer is made and accepted, but either party can bow out if those conditions aren’t satisfied. Most people think of contingencies as being tied to financial concerns. A buyer can make an offer, but it is contingent upon them obtaining a mortgage. Actually, there are at least six common contingencies and financial contingencies aren’t the most prevalent.
According to a survey conducted by the National Association of RealtorsⓇ (NAR), of the buyer’s agents who responded to the January 2018 REALTORS® Confidence Index Survey, 76 percent of those who closed a sale in January 2018 reported that the closed sale had a buyer contingency. A contingency isn’t just a conditional offer by the buyer, it also places some of the burden onto the seller. The seller must be able to meet certain conditions as well, such as disclosing previous damage or repairs.
Let’s work through the five most common buying contingencies and how buyers can ensure their offer rises to the top.
In the NAR survey, home inspection was the most common contingency, at 58 percent. In a home inspection contingency, the buyer makes their offer with the stipulation that it is only valid if the independent inspection report 1) doesn’t reveal anything the buyer wasn’t already aware of, or 2) the inspector discovers problems the buyer isn’t willing to negotiate or repair. The buyer is responsible for ordering the home inspection and hiring an inspector, which costs around $400 for a home 2,000 square feet or larger, according to Home Advisor.
There is no such thing as a completely clean inspection report, even on new construction. Inevitably, issues are found. Many issues are easy fixes or simply information to alert home buyers of a potential problem. Some issues are big, particularly when they have anything to do with structural issues, like foundation problems, a crumbling chimney or live termites. Electrical, plumbing, drainage and HVAC problems are common and can be expensive to repair or bring up to code in older homes. In these instances, homebuyers can either rescind their offer with no penalty and look elsewhere, negotiate with the seller to have them make repairs, or reduce the offer price. If the seller is unwilling to meet these conditions, the buyer can rescind their offer without losing their earnest money.
Because anyone who has ever purchased or sold a house knows inspections uncover all kinds of things, the inspection process is generally quite stressful for both buyers and sellers. The buyer obviously has their heart set on buying the home and would be disappointed if their inspection-contingent offer was rejected or warranted a rescinded offer. This would require a new home search. The seller, on the other hand, may or may not know of damages, wear-and-tear or code violations in their home, but they want to sell as quickly as possible. Everything rides on the inspector – what he or she will find, how it will be reported and whether any issues are big enough to halt the sale of the home.
For the seller, the inspection report must be made available to the next buyers if the deal with the original buyers falls through. The seller then must decide whether to reduce the asking price of their home to account for known repairs that will need to be made, or they will have to hope the next buyers are more willing to accept the inspection findings.
In an appraisal contingency, the buyer makes their offer, the seller accepts it, but the deal is contingent upon the lender appraisal. If the buyer is seeking financing from a lender, the lender will require an appraisal of the property to ensure the asking price is in line with the actual assessed value of the home. Lenders will look at “comps” (comparable houses that have recently sold in the area) to see if the home is within the same price range. A third-party appraiser will also go onsite to the property to measure its square footage, as tax records may list incorrect or outdated numbers. The appraiser will also look at the condition of the property, where it is situated in the neighborhood, renovations, features and finish-outs, backyard amenities, and other considerations.
The appraiser will combine the comps, tax records and personal assessment to determine the appraised value of the home. If his or her assessment is in line with the asking price of the home, the buyer will move forward with the deal. If, however, the appraisal comes in lower than the asking price, the seller must either lower their asking price to match the assessed value, or they can boldly ask the buyer to make up the difference with cash. If the difference between the appraisal and the asking price is minimal, some buyers will agree to put forth their own cash so as not to lose the house. Much of the time, however, the appraisal contingency means the buyer is unwilling to front the difference. They can rescind their offer without losing their earnest money.
According to the NAR survey mentioned above, 44 percent of closed home sales included a financing contingency. A financing contingency is when the buyer makes an offer, the seller accepts, but the sale is contingent on the buyer obtaining financing from a lender. There are plenty of issues that can come up with financing. All that the lender cares about is whether the buyer will be able to pay their mortgage. They will check the buyer’s credit score, debt to income ratio, job tenure and salary, previous and current liens, and other variables that could impact their decision to loan or not.
The financing process can often take time and is why home sales can take more than 60 days to close. Buyers can find themselves at the end of their option period, believing the new home is theirs, then be notified there was a problem with their financing. If the buyer can’t obtain financing, then the financing contingency allows the offer to be canceled and the earnest money returned (typically 1 to 5 percent of the sales price).
To avoid such disappointments and to sweeten their offer by convincing the seller that they can back their offer up with financing (particularly in a seller’s market), buyers may choose to obtain a mortgage pre-approval before they begin the home search. In this situation, the buyer goes through the standard lender review process and is told how much they are approved for. The buyer can then narrow their home search to properties at or below this value, make their offer, and give the seller a pre-approval letter from their lender stating the buyer is approved for a certain amount under specific terms. The offer, however, has a shelf life. It’s typically only good for 90 days. An all-cash offer is the best way to eliminate the need for a financing contingency.
Most buyers face a similar dilemma: they must sell their current home before they can afford to buy their next home. In these situations, the buyer will make their offer on the new home with the contingency that they must sell their existing home first. Many sellers try to avoid this type of contingency because it forces them to place their home sale as “pending,” which can deter other buyers from making an offer. It also means delay. They can’t sell their home until their buyer sells their home. Complications are common and from a seller’s point of view, home sale-contingent offers are the weakest on the table.
For these reasons, many real estate agents advise against home sale contingencies. It’s a stressful predicament that agents and home buyers want to avoid, if possible. Securing cash to make an all-cash offer can remove this burden and enable home buyers to buy whenever they find what they’re looking for instead of having to time the sell/buy process perfectly. All-cash offers inevitably win against home sale-contingent offers.
In some circumstances, the title company will discover problems with the property’s record of ownership. It may be that there is an unsettled lien from a previous owner or judgment on the property if there was a divorce or unpaid taxes, for instance. In these situations, the ownership issues can cause a buyer to back out of a contract without penalty if the attorneys or title company cannot resolve them. The good news is, most title issues can be resolved easily, but as a home buyer, you want to be sure you’re protected by making your offer contingent upon a clean title.
Contingencies are quite common, however, they can cause an offer to be weaker than a non-contingent offer. As any home seller will tell you, a clean, non-contingent offer is attractive and often favored over contingent ones. The home sale process moves much more smoothly and quickly without these contingencies tied to them. Fewer roadblocks means less stress for both the buyer and the seller.
So, how do you make a non-contingent offer? To avoid a home sale contingency, financing contingency and appraisal contingency in one solution, your best bet is to make an all-cash offer. Since most people don’t have enough liquid assets to purchase a new home outright, they may need to borrow or use other funds to do so. A new trend is to go with a company like Homeward that offers you their cash to make the home purchase – with no interest. You pay a small usage fee and lease back your new home from them until your existing home sells. As soon as you close on the sale of your old home, you get your own mortgage on your new home and pay Homeward back.
Inspection and title contingencies can also be minimized. Many home sellers have their homes pre-inspected and repaired before they ever put it on the market. Look for those. Otherwise, you may want to look at newer homes that may have fewer issues. But, even the best-built homes will likely have issues. If you want to protect yourself from having to make costly repairs after purchase, you may want to keep the inspection contingency on the table. It pressures the seller to either make repairs or negotiate their price if they want to sell at or above market value.
Title contingencies are usually fixable. It may delay your closing as the title company and lawyers hash it out, but if you love the home and are willing to wait, you’ll likely get to close without issue. Just be sure you’re kept in the loop so you can make a decision if needed.