Most Common Contingency Clauses
Whether you’re a first time home buyer or a seller, new to real estate or a long-time investor, you’re probably familiar with the beginning of most residential real estate transactions: A buyer makes an offer to the seller, who accepts, rejects, or, most often, counteroffers. As negotiations continue, either party can walk away, no foul.
However, once both parties agree to the terms, the buyer makes an earnest money deposit and a contract is signed. Once the pen is put to paper, both parties are accountable for the sale and can’t walk away—unless their contingencies aren’t met. Contingency clauses are conditions that need to be met in order for the contract to be binding, protecting both the buyer and seller from deals that go south.
Here, we’ll review the most common contingencies that benefit buyers and sellers so you know what to look out for in or add to a real estate contract.
What Is a Contingency?
A contingency clause defines a condition or action that must be met or avoided before the real estate transaction can move forward. Contingency clauses are included in the sales contract and are official and binding once both the buyer and seller sign that contract. Contingencies can relate to everything from inspection and the home’s condition to financing. If all the contingencies are met, the contract is binding. But if the terms aren’t met, either party can bow out without negative consequences.
Most often contingency clauses are intended to protect the buyer and ensure they can step away from the sale—and get their earnest money back—if the sale doesn’t work out as expected. However, contingency clauses are also intended to protect the seller. If contingencies are met and the buyer walks away, the seller can actually sue for specific performance and the buyer will have to purchase the home.
As a buyer (or even a seller), contingency clauses sound pretty foolproof, right? While contingencies can protect you, it’s worth noting that they should be employed sparingly. The more contingencies a potential buyer attaches to an offer, the less appealing it is to a seller
There are also some specific requirements for contingencies that both parties must follow. In order for contingencies to work, they should be…
Conditional: Contingency contracts are dependent on the completion of certain tasks or avoiding certain scenarios. So if the condition doesn’t happen, fulfilling it isn’t necessary.
Specific: Contingencies need to be specific and measurable so that they aren’t open to interpretation. Both parties need to agree on the specific aspects of the condition so that they can understand and agree when it has been completed. For example, a contingency can’t just say the property needs to be upgraded because that’s immeasurable. It can, however, state that the seller must repair the roof before closing.
Have Deadlines: In today’s market, real estate transactions are almost always time-sensitive, which is why it’s important to set a timeline for contingencies. This ensures that the closing process continues according to schedule and provides an end-date for obligations. It also holds both the buyer and seller accountable.
The Agreement Should Be Binding: Finally, buyers and sellers should both be sure to include their requested contingency clauses and outline them specifically in an official, written contract. This guarantees that conditions are agreed upon and met, plus it helps both parties know how to move forward if they’re not.
You can include all kinds of contingencies in your contract but, like we said, you should be really intentional with your contingencies in order to seal the deal. Some of the most common contingencies include:
When buying a home, an inspection provides the buyer with insight into the condition of the house. It includes an examination of its interior, exterior, and systems (like HVAC, plumbing, etcetera). Inspections also cover aspects of the home that aren’t immediately visible, like mold or termite damage. After the inspection is done, the buyer receives a report that outlines what the inspector found as well as suggestions for repairs.
Home inspection contingencies give the buyer the opportunity to have the house inspected and the ability to negotiate the purchase price or repairs based on what the inspection turns up. Depending on what the inspection reveals, the buyer could ask the seller to make renovations or lower the price; if the seller doesn’t agree—or if it just seems like too much work—the buyer can leave the negotiations scot-free.
Also known as “mortgage contingencies,” financing contingencies ensure the buyer has time to apply for and receive financing, (i.e. a mortgage loan). Many buyers assume that because they were pre-approved for a loan, it’s guaranteed, but it’s not—it’s only the beginning of the loan process.
While mortgage contingencies are intended to protect the buyer, allowing them to end the contract and reclaim their earnest money if they can’t secure financing, there are rules here to safeguard both parties. This contingency offers the buyer a specific number of days to receive financing from a bank, mortgage broker, or other lenders. If it doesn’t work out, the buyer has until that date to end the contract or request an extension (which has to be put in writing and signed by both parties). If the buyer doesn’t terminate the contract or extend the contingency, they’re legally obligated to purchase the property—regardless of whether or not they get a loan.
Appraisals define the market value of a house. Appraisal contingencies are inherently tied to financial contingencies because a satisfactory appraisal is a condition most mortgage companies require before offering buyers a loan. The mortgage company will only loan the buyer the amount of the appraised market value. These contingencies protect the buyer, providing room for negotiation if the appraisal comes in well below the offered price.
These contingencies represent the importance of setting and minding deadlines in contingencies: The buyer must notify the seller of any issues with the appraisal by a predetermined date—or else the contingency is deemed satisfied, and they’re obligated to move forward with the offer price.
Sure, you’ve heard of car titles, but houses have titles too. These titles serve as a record of the house’s ownership and any liens or judgments that have been made against the property. A title company or the buyer’s attorney usually reviews the title of the home and checks for any issues so that the title can be transferred free and clear. Sometimes, however, those issues are too big to solve before closing, in which case, the title contingency protects the buyer from those obligations and allows them to leave the sale.
Home Sale & Kick-Out Contingencies
Home sale contingencies allow for the buyer to sell their current home before closing in order to finance their new house; if they can’t find a buyer in time, they can walk away from the contract with their earnest money. While it’s great for the buyer, these contingencies tend to leave sellers in a sticky situation, especially when they take their home off the market and the sale falls through. Therefore, these contingencies aren’t used very often as it might turn off the seller and push them to turn down a buyer’s offer.
That being said, the kick-out contingency is the seller’s safeguard against the negative consequences of a home sale contingency. While the seller agrees to the home sale, it’s with the condition that they can continue to market the house; if a new buyer makes an offer, the first buyer has a certain amount of time to remove the home sale contingency. If they don’t, the seller can squelch the contract and move forward with the new buyer.
Why Contingencies Matter
The stakes always feel high when you’re buying or selling a house, and it’s tempting to leave out contingencies to help move the sale along. But many buyers and even sellers have lived to learn the lesson of a lack of contingencies when they were left with major repairs or holes in their pockets. Contingencies are designed to hold both parties accountable and offer an escape hatch if you need it. It’s important to understand what contingencies are and which ones are common in order to incorporate them into your contract and avoid any of those negative consequences.
Opinions expressed are solely my own and do not express the views of my employer.