Question: Admittedly, I thought I would be more successful learning about the home-buying process online, but realizing it’s difficult to get clear answers that apply locally. I’m getting confused about the meaning and impact of a contingency and hoping you can explain what contingent means and what I should know about contingent contracts in this area.
Answer: There are plenty of educational resources online about buying a home, but local customs and contracts differ so much by state or region that a great explanation of a topic by an agent in New York may prove to be misleading for a home-buyer in Northern VA. I always recommend that our clients spend some time up-front with us discussing key milestones and contract protocol. You’d be surprised how much even the most seasoned buyers can learn during a 30-60 minute review of the buying process.
Contingencies, in a real estate transaction, are clauses or addendums added to the Purchase Agreement that give one party the right to cancel or renegotiate the contract if certain things do or do not happen within a pre-determined period of time. Nearly every contingency you will need is a pre-written form offered by the local Realtors Association (e.g Northern Virginia Association of Realtors) so you don’t have to worry about hiring an attorney to draft the language unless you find yourself in an unusual situation. If a Buyer cancels the sale within the legal limits of a contingency, they receive a 100% return of their deposit/escrow (Earnest Money Deposit).
The Big Three
There are three standard contingencies used in almost every sale – Home Inspection Contingency, Financing Contingency, and Appraisal Contingency. Like most contingencies, they protect the Buyer. However, they are not required so Buyers may decide to remove some or all of their contingencies in order to improve the strength of their offer. Fewer contingencies = fewer barriers to sale = more attractive to a Seller.
Home Inspection Contingency: This provides Buyers the right to hire a 3rd party home inspector (your Agent should be able to recommend somebody), followed by the Buyer’s right to negotiate for repairs and/or credits from the Seller and/or the ability to void the contract if an agreement on repairs/credits can’t be reached. Buyers may elect for a Pass/Fail Contingency which eliminates their right to negotiate repairs/credits, but leaves intact the right to void. Nobody other than the Buyer can decide whether a home passes or fails inspection. The Inspection Contingency Addendum also includes a section for Radon testing, which is applicable when a home has a livable underground basement.
Financing Contingency: A Financing Contingency protects the Buyer in the event that they are unable to secure a loan to purchase the home. If a Buyer is rejected from their loan application for any reason other than personally sabotaging the loan (e.g. not delivering required documents), they have the right to void the contract. This is why it is important for Sellers to vet their Buyer’s pre-approval letter before accepting an offer to make sure they have been fully qualified by a reputable lender. Your Agent should know how to vet the approval and whether there are any red flags.
Appraisal Contingency: If you are taking out a loan to purchase your home, the lender will most likely require a 3rd party appraisal. The Appraisal Contingency protects Buyers in the event the appraised value is less than the purchase price. It allows the Buyer to renegotiate the purchase price, add more equity to the loan to maintain their down payment percentage, leave the equity unchanged and reduce the down payment percentage, or void the contract.
Other less common contingencies include the Association Document Review, which offers Buyers a non-negotiable three-day review period any time they purchase a home in an Association (Condo, Coop, HOA, POA) to review the Resale Package which includes documents like by-laws, rules, budget, and reserve study. Upon delivery, Buyers are able to cancel the contract for any reason within three days of receipt.
Another less common contingency relates to the purchase or sale of another home. Sellers may include a contingency that states they must find a home to purchase before they will sell their current home and Buyers may include a contingency that requires them to sell their home before they purchase their next home.
After purchase price, contingencies are the next most important terms in a negotiation. You should spend time early in your buying process talking with your Agent about the most efficient use of contingencies to maximize your protection while not unnecessarily compromising the strength of your offer.
This is especially important if you are making an offer on a home that has been on the market for less than two weeks and there is a chance for multiple offers. The winning offer is not always the highest price, but the one who presents the best overall contract. Even in non-competing offers, you may save yourself money on the final purchase price by using contingencies and other terms more efficiently.
As always, if you would like to set-up time to discuss this topic in more detail, don’t hesitate to email me at Eli@EliResidential.com to schedule a meeting. Now go finish up your holiday shopping!