If you've ever taken part in a real estate deal, you've probably come across at least one contingency clause. These are provisions in home purchase contracts that define a specific action or condition that must be met for the contract to become binding. If the contingency isn't met, the parties could legally back out of the deal.
Contingencies are a normal part of the negotiation process. They help protect both buyers and sellers and ultimately determine the fate of a real estate deal. As a result, it's important to understand what you're getting into when a contingency clause is part of your real estate contract.
Common contingency clauses
You can write a contingency clause for almost any reason. However, these four clauses tend to show up in a lot of home purchase contracts:
- Appraisal contingencies
- Financing contingencies
- Inspection contingencies
- Title contingencies
Here's a closer look at each.
1. Appraisal contingencies
If you're buying real estate, you might need a mortgage to finance the deal. A critical part of the mortgage process is the appraisal: an estimate of the home's current fair market value. In general, lenders won't give you a mortgage for more than the appraised value of the home.
An appraisal contingency protects the buyer by ensuring the property appraises at a minimum, specified amount. If it doesn't, you may be able to renegotiate the sale price with the seller or find additional financing. But there will be a strict deadline for doing so. If these options fall through, you can back out of the contract because of the appraisal contingency. And in many cases, you'll get back your earnest money deposit, too.
2. Financing contingencies
Financing contingencies are also called mortgage contingencies. This type of contingency gives the buyer time to apply for and obtain financing to buy the property. If you can't get financing for whatever reason, you can back out of the contract and reclaim your earnest money.
Keep in mind that there's a time limit for finding financing, and you will have until a certain date to terminate the contract (or request an extension). Otherwise, you automatically waive the contingency. And that means you're legally obligated to buy the property – even if you don't get the loan.
3. Inspection contingencies
An inspection contingency (or due diligence contingency) gives the buyer the right to get the home inspected before a certain date. An inspector examines the property's interior and exterior to look for any problems. Those can include structural, electrical, plumbing, and HVAC issues, as well as complications with mold, termites, roaches, or other pests.
Depending on the terms of the inspection contingency, you can:
- Approve based on the inspection report (and the deal moves forward)
- Disapprove based on the report and back out of the deal (and get your earnest money back)
- Request more time for another inspection if something needs a closer look
- Request repairs or concessions from the seller (if they agree, the deal goes forward; if they don't, you can back out)
4. Title contingencies
A property's title is its legal record of ownership. It shows who owned the property in the past, and who owns it now. It also reveals if there are any liens or other encumbrances against the property. In most real estate transactions, a title company or real estate attorney performs a title search to find any clouds, or defects, on the title. If there are any, they can often be resolved before closing.
Sometimes, however, a title defect can't be resolved quickly. If so a title contingency allows you to back out of the sale. Otherwise, you could end up in a situation where a third-party contests the ownership or where you are liable to pay off someone else's debts.
These four contingency clauses are the most common, but there are certainly others out there, including home sale contingencies. These give a buyer time to sell and settle their current home in order to finance the new one. If they can't find a buyer, they can back out of the deal.
Home sale contingencies used to be more common, but they are hard on the seller, who could be forced to pass on another offer while waiting for the results of the home sale contingency. As a result, many sellers pass on offers that have this type of contingency.
Pay attention to the details
Contingency clauses are a good layer of security for both parties in a real estate transaction since they grant buyers and sellers the right to back out of the contract if certain conditions or actions aren't met. If the conditions aren't met, the contract becomes null and void. In that case, one party (typically the buyer) can back out with no legal consequences. Of course, if the conditions are met, the contract becomes legally enforceable.
If your real estate contract has a contingency clause (which is likely), make sure you understand what it means. Pay close attention to any dates specified in the contract. One missed deadline could make you lose out on the sale.
In some states, real estate professionals can prepare contracts and any modifications, including contingency clauses. However, other states require licensed attorneys to draw up these documents. Make sure you follow your state's laws to be sure your contract and any contingency clauses are valid. If you're working with an experienced real estate sales agent or broker, they can guide you through the process.