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About Contingency Clauses in Real Estate
The condition or action which must be met for a real estate contract to become binding is termed contingency clauses.
When both parties, the buyer and the seller, agree to the terms and sign the contract then the contingency becomes part of a binding sales contract.
If a contingency clause is included in your real estate contract then it is crucial to understand what you’re getting into.
Let us look into widely used contingency clauses in home purchase contracts and how they will benefit both buyers and sellers.
Real Estate Contracts
Here a buyer presents a purchase offer to the seller, who can either accept or reject it. Often, with the counter from the seller, the negotiations go carry on until both parties reach an agreement.
If they do not agree to the terms, the offer gets nullified, and both the buyer and seller go their separate ways with no further obligation.
If there is an agreement to the term by both parties then an earnest money deposit is made by the buyer, which is a sum paid as evidence of good faith, which could be 1% or 2% of the sale price.
An escrow company holds the funds while the closing process begins.
At times a contingency clause is linked to an offer during real estate purchase and also included in the real estate contract.
With the help of a contingency clause, the parties get the right to back out of the contract under certain circumstances that must be negotiated between the buyer and seller.
The details such as the time frame – where the buyer has 14 days to inspect the property and specific terms like – the buyer has 21 days to lock a 30-year conventional loan for 80% of the purchase price with interest lower than 4.5% are included in contingencies.
All contingency clauses are very clear so that all parties understand the terms.
If the contingency clause conditions are not met, the contract becomes invalid, and the buyer can back out without any legal consequences.
And the contract is legally enforceable if the conditions are met, and if a party decides to back out then it would be in breach of contract.
Resulting in varying consequences from confiscation of earnest money to lawsuits.
For instance, if a buyer backs out leading to the seller not able to find another buyer, then the seller can sue for specific performance, compelling the buyer to purchase the home.
Types of Contingency Clauses
For almost any need or concern can have a contingency clause written. Some of the most common contingencies in current home purchase contracts are:
1 - Appraisal Contingency
The buyer is protected in an appraisal contingency and it is used to check that a property is valued at a minimum, specified amount.
The contract can be terminated, if the property does not appraise for the specified amount, and the earnest money is refunded to the buyer in most cases.
Even if the appraisal is below the specified amount an appraisal contingency can have terms that permits the buyer to go ahead with his purchase, within a specified number of days after he receives the notice of appraisal value.
The seller can lower the price of the appraisal amount.
The buyer should inform the seller of any issues with the appraisal in the contingency on or before the release date.
Or, the contingency will be considered satisfactory, after which the buyer cannot back out of the transaction.
2 - Financing Contingency
This is also called mortgage consistency, which allows time for the buyer so he can apply for and obtain financing for the purchase of the property.
In case they are not able to secure financing from a bank, mortgage broker, or another type of lending then it provides protection for the buyer, so he can back out of the contract and reclaim his earnest money.
A financial contingency consists of a defined number of days within which the buyer has to obtain financing.
Until this date, the buyer has time to either terminate the contract or request for an extension which the seller must agree to in writing.
If not done so, the buyer waives the contingency and is obligated to purchase the property, even if his loan is not secured.
3 - Home Sale Contingency
Usually, it is easier to sell before buying another property, but not always do the timing and financing work out that way.
Here, the buyer gets a specified amount of time to sell and settle their existing home in order to finance a new one.
A buyer is protected in this type of contingency because, if an existing home doesn’t sell for the asking price, then the buyer can back out of the contract without any legal issues.
A house sale contingency is difficult on the seller, because at times he may be forced to pass up another offer while waiting for the outcome of the contingency.
If the buyer’s home is not sold within the set-out number of days then the seller holds the right to cancel the contract.
4 - Inspection Contingency
It is also called a due diligence contingency because in this contingency the buyer has the right to have the home inspected within a specified time period, like five to seven days.
Inspection contingency protects the buyer, who can based on the findings of a professional home inspector, cancel the contract or negotiate repairs.
The property’s interior and exterior, including the condition of electrical, finish, plumbing, structural, and ventilation elements are all examined by an inspector.
Then a report is furnished to the buyer giving in detail any issues discovered during the inspection. Depending on the inspection contingency terms the buyer can:
- Approve the report, and move the deal ahead
- Or disapprove the report, and back out from the deal, and get the earnest money returned
- If something needs a second look they can request some time for further inspections.
- If the seller agrees, and the deal is on, then the buyer can request for repairs or a concession, and if the seller refuses then the buyer can back out of the deal and also take back the earnest money.
In addition to the inspection contingency, a cost-of-repair contingency is included sometimes.
Which specifies the maximum dollar amount for the repairs. If during the home inspection it indicates that the repairs will cost more than this dollar amount, the buyer can choose to terminate the contract.
The cost-of-repair contingency many times depends on a certain percentage of the sales price, like 1% or 2%.
5 - Kick-out clause contingency
To provide some protection against a house sale contingency the sellers add a kick-out clause.
While agreeing to a house sale contingency the seller can add a kick-out clause which states that the seller can still continue to market the property.
If another qualified buyer comes in, then the seller gives the current buyer a specified time like 72 hours to remove the house sale contingency and keep the contract alive. the seller can back out of the contract and sell the home to the new buyer.
Conclusion
A contingency clause is defined as a condition that must be met for a real estate contract to become binding.
An appraisal contingency is used to ensure a property is valued at a minimum, the specified amount thus protecting the buyer.
The buyer gets time to obtain financing for the purchase of the property in case of a financing contingency/mortgage contingency.
Contingencies are clauses that are part of the real estate contract. As time is of the essence pay attention to all specified dates and deadlines as it would lead to a negative effect.
In some states, the real estate professionals prepare contracts and contingency clauses while in some it needs to be worked on by licensed attorneys.
