What to Know About Contract Contingencies

A realtor and buyer talking about the real estate contract and contingencies to include.

There are many steps to purchasing a new home. After the initial offer is made, buyers and sellers often negotiate before they come to an agreement. Buyers then deposit earnest money to show they are serious about the purchase, and both parties begin the closing process.

However, a lot of things can go wrong between signing the contract and closing on a house. To protect buyers, several types of contract contingencies may be included in the contract. These allow the buyer to legally back out of the sale if necessary.

Many home contract contingencies are accepted by sellers, but some may weaken offers on a home. Here are four common types of home contract contingencies and how to tell which ones may be right for you.

1. Financing Contingency

Financing contingencies are sometimes also known as mortgage contingencies. They protect the buyer from having to complete a sale they can’t afford. Financing contingencies are an important part of your contract, and they’re commonly accepted by sellers.

Most buyers can’t afford to pay cash for a home. To complete their purchase, they must be approved by a lender who agrees to lend them the money. Lenders research buyers’ financial history to ensure they will pay the money back on time.

If lenders aren’t satisfied with a buyer’s financial history, they may refuse to give them a loan. Unfortunately, the buyer may have already signed a contract with a seller at this point. A financing contingency protects buyers from having to go through with the sale if financing for the home falls through.

Although getting pre-approved for a loan can make the process smoother, it’s not a guarantee of a loan. As a buyer, you should include a financing contingency in your contract even if you’ve been pre-approved.

2. Appraisal Contingency

Like financing contingencies, appraisal contingencies protect buyers from legally agreeing to buy a home before they have the financial resources to pay for it. Before they lend buyers money, lenders will complete an appraisal on the home they’re borrowing money for.

If they find the home is worth less than it’s being sold for, the lender may not give the buyer enough money for the full purchase cost. For example, a lender may appraise a house that’s being sold for $170,000 as only worth $150,000 on the current market. Based on their research, they’ll only lend the buyer $150,000.

At this point, the buyer and seller have several options. They can renegotiate the price to a lower amount, or the buyer can look for additional financing to cover the difference. However, if their home contract has an appraisal contingency, the buyer can also back out of the sale without any legal repercussions.

3. Inspection Contingency

Before a home sale goes through, many buyers like to hire an inspector to check that there are no major issues with the property. Inspection contingencies are clauses in a home contract that protect the buyer from continuing with a sale if major issues are found.

Unless it’s new construction, every home has problems that need to be fixed. However, these problems can range from broken appliances and squeaky doors to mold and foundation issues. While minor issues can be fixed easily, some major issues could be unsafe and cost new buyers a lot of money to fix.

Inspection contingencies cover any surprises that crop up during inspection and may change the buyer’s mind about completing the sale. After an inspection occurs, buyers and sellers with an inspection contingency in their contract can renegotiate. Buyers can also choose to walk away from the sale if the damage is too much for them.

After a home inspection, sellers are required to tell the next buyer who makes an offer what the inspector found. This gives them the incentive to compromise and finalize the sale with the original buyer if there’s a major issue.

4. Home Sale Contingency

Often, buyers are trying to sell their own homes at the same time they’re searching for a new place to live. Ideally, their first home sells around the same time as a new purchase goes through. However, this doesn’t always happen.

To protect themselves from having to pay for two homes at once, some buyers add a home sale contingency clause to their offer. This means the sale of a new home won’t go through until after their first home sells.

Home sale contingencies aren’t great for sellers because they must take their house off the market without knowing if the sale will go through. In today’s market, sellers generally will pass up an offer with a home sale contingency and wait for an offer that’s better for them.

In some cases, sellers will allow a home sale contingency and add a kick-out clause to protect themselves from a drawn-out sale process. This clause enables them to keep marketing their home, and they’re able to give the first buyer an ultimatum if they receive a second offer that’s better for them.

Everything You Need to Know About Contingencies

Contingencies legally and financially protect buyers in home deals that go sour. However, not all contingencies are welcome to sellers. To help you decide which contingencies to include in your home contract, talk with your real estate agent and compromise only on what you can afford.

About the Author: Evelyn Long is the editor-in-chief of Renovated, an online resource for the real estate market. Her freelance writing has been published by the National Association of REALTORS®, Insights for Professionals and other prominent industry magazines.

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