Making an offer to buy a home can be intimidating — it’s often one of the most significant purchases most people will ever make! To protect themselves, buyers will sometimes add contingencies to the contract.
Understanding this tool and how it affects real estate transactions is crucial. Read on to understand what a contingency is, and the common types you’ll see on a contract.
What Does Contingency Mean?
A contingency is defined as a “future event or circumstance which is possible but cannot be predicted with certainty.” In real estate, this refers to a specific action or item in the contract that must happen for the contract to become legally binding.
While most sellers prefer to receive a contingency-free offer from a buyer, they can be valuable tools for both the buyer and seller to back out of the contract. They provide buyers an out if conditions aren’t met.
There are tons of contingencies, but the four most common are appraisal, inspection, loan, and home sale.
What is an Appraisal Contingency?
An appraisal contingency ensures that your home’s appraisal is in line with your purchase price. This helps confirm that the buyer is purchasing the home for the appropriate fair market value; if not, they can back out of the contract.
If the appraisal comes back higher than the purchase price, there is generally no issues for the buyer or the bank. But if the appraisal determines the home is not worth the purchase price, there can be issues for the buyer.
Lenders will often not loan money for more than a home is worth. Therefore, a low appraisal can mean the seller might have to decrease the property’s price, or the buyer will have to pay the difference in cash between the appraisal and purchase price.
However, the buyer can back out of the contract if there is an appraisal contingency. It can also stipulate that if the appraisal comes in lower, the seller will reduce the price to the appraised value.
What is an Inspection Contingency?
A home inspection contingency is often the most common real estate contingency. The National Association of Realtors® estimates that about 80% of buyers include a home inspection contingency in their contract.
This contingency gives the buyer a window of time to inspect the property professionally by a third party and determine if there are any issues with the house. They will review the exterior and interior structures and systems during this process. This includes things like HVAC, electricity, plumbing, roofing, and more.
If the inspection comes back with major issues, the inspection contingency clause will allow the buyer to back out of the contract, or potentially negotiate with the seller to have the issues fixed before closing on the property. If your seller is unwilling to address the problems, the contingency will allow you to terminate the contract while receiving your earnest money deposit back.
An inspection contingency is crucial to ensure that you’re not stuck purchasing a defective property riddled with problems.
What is a Loan Contingency?
A loan contingency, sometimes called a mortgage or financing contingency, states that the contract is contingent on the buyer getting their financing approved from a lender.
Often a buyer will get pre-approved before starting their home search, which indicates a lender has already taken an initial look at their finances and determined if they are eligible for a loan. But, once the underwriting process begins, there can be problems finalizing or securing the loan.
A loan contingency allows the buyer to back out of the contract and receive their earnest money deposit back if they can’t qualify for a loan by a specific date. This usually gives 30 to 60 days to finalize the loan with a lender.
This contingency can also benefit the seller, allowing them to cancel the contract if the buyer hasn’t gotten financing approval by the set date. If this happens, the seller will have to put the home back on the market and try to find a new buyer.
If a buyer is prepared to purchase a home with cash, they will waive a financing contingency since they don’t need to secure a loan to go through with the purchase. A cash offer is often seen as more appealing to a seller who doesn’t have to worry about the buyer getting a loan to purchase the property.
What is a Home Sale Contingency?
If a buyer is trying to sell their old home before purchasing a new home, they can include a home sale contingency — otherwise known as a concurrent closing.
This ensures that the buyer is able to close on their old home, and move forward with purchasing the new home. The buyer might need the proceeds from the sale of their old home or want to avoid paying two mortgages at once.
With almost half of buyers already owning a home, this contingency is extremely common if the buyer has a home to sell. Before accepting an offer contingent on the sale of the buyer’s home, the seller might want to consider a few things, like if the house is already on the market or under contract.
If the buyer’s home doesn’t sell or get under contract within the specified time, the seller can walk away and put the home back on the market or negotiate with the buyer to extend the contract.
Sometimes a “kick out” clause is included in this contingency, which allows the home to stay publicly on the market while the buyer tries to sell their home. In this case, the seller could accept another offer and move forward with that contract instead.
Real Estate Contingency Period
If there is an offer with contingencies, the buyer and seller generally have 30-60 days to ensure the contingencies are met. This is also known as the “contingency period.” This time frame can be shorter or longer depending on the terms agreed on but time is of the essence when contingencies are included.
If the buyer doesn’t take the necessary steps to ensure the contingencies are met, the contract could fall through and they could lose the home. This also means that sellers will have to put the home back on the market — something that no one wants to happen!
Contingent vs Pending in Real Estate
A home that is under contract can be a contingent or pending offer. In the case of a contingent contract, the seller can keep the listing active in the MLS if the buyer's contingencies aren’t met. But if the property is listed as “pending,” it means there weren’t any contingencies in the offer or all the terms were met.
During the contract negotiations, a seller might accept a contingent offer but still continue showing the property or even accept other offers — like the “kick out” clause explained earlier.
Final Thoughts Contingencies in Real Estate
Many different types of contingencies can be included in your home purchase contract. While these can help protect the buyer, sellers often see these stipulations as hurdles to selling their house.
A great real estate agent can guide clients through the offer process and ensure the right contingencies are in place to protect their best interests.
