Contingencies are pretty common in real estate. In fact, aside from cash ones, most offers include at least one contingency clause to protect the buyer. Are you currently selling a property? Wondering "Should I accept a contingent offer on my house or investment property?" Here’s what you need to know to decide.
What is a contingent offer?
A contingent offer refers to an offer on a house that hinges on certain conditions -- or contingencies. It basically means that the buyer wants to purchase the house, but these conditions will need to be met before they’ll finalize the deal.
There are four common types of contingencies you might see in an offer:
- Mortgage contingency: This says the purchase is reliant on the buyer’s ability to get a mortgage loan. If they’re unable to secure financing, they can back out of the deal.
- Inspection contingency: The inspection contingency allows the buyer to have the home inspected. Once the inspection is complete, the buyer can either renegotiate or cancel the contract based on its findings.
- Appraisal contingency: With an appraisal contingency, buyers have the option to break the contract if the home doesn’t appraise at the price offered.
- Home sale contingency: Home sale contingencies are for buyers who are also selling their current property. They allow the buyer to back out of the transaction if they’re unable to find a buyer for their home within a certain time period.
Some types of contingent offers are riskier than others. Home sale contingencies, for example, are extremely risky, since they make your sale reliant on the sale of another property (potentially two, if the prospective buyer’s buyer has to sell a house, too).
The drawbacks of contingent offers
Accepting a contingent offer really only has one benefit: You might have a done deal.
But that’s a big "might." Contingencies come with real risks, and if you take your home off the market in hopes those conditions will be met, you could find yourself disappointed weeks or months down the line. In that case, you’d have to start over and find another buyer.
This could throw off your own goals (maybe you were trying to buy another property), as well as any deadlines you were trying to meet (investors might need to sell before their hard money loan gets more expensive).
All in all, the drawbacks of accepting a contingent offer include:
- The deal might fall through.
- You might have to renegotiate or accept a lower price.
- It could take longer to sell your home.
- It could cause financial problems or make it hard to buy your next property.
The main point is that contingent offers are risky, and you’ll want to seriously consider whether it’s right for your situation before signing on that dotted line.
Making your decision
If you’re faced with a contingent offer, there are a lot of factors to take into account when making your decision. The first is what kind of contingency you’re looking at.
Type of contingency matters
Financing contingencies are pretty standard, and while they do come with some risks, you can usually reduce that risk by thoroughly evaluating the potential buyer before agreeing to the contract.
- Is the buyer preapproved for a mortgage?
- What kind of loan are they preapproved for? (A conventional mortgage likely means they have good credit and are a safe bet.)
- Do they have a decent-sized down payment?
If the home buyer seems like a safe bet to get approved for a loan, then the financing contingency generally isn’t a huge worry.
Home inspection and appraisal contingencies are slightly riskier, though most buyers will be willing to negotiate if a minor defect crops up or the home appraises slightly under the sales price. Still, it could mean losing out on some cash.
You can reduce these risks by getting an inspection before you list to identify any problems on the property, as well as working with a real estate agent to appropriately price your home based on current market values.
Home sale contingencies carry the biggest risk. They make your sale reliant on the sale of another property -- sometimes even two. Though concurrent closings can happen in some cases, it’s a complicated process, and you’re more likely to lose the buyer than with other contingencies on this list.
How will it impact your finances?
You also need to look at how the offer could impact your financial situation. If the sale falls through, will it mean making two mortgage payments? Will it be hard to keep your other investments afloat? Will you lose the cash for another property you’re looking to purchase?
Look carefully at your finances (or the finances of your investment business) and make sure you understand how the fallout could affect them before accepting the offer.
Consider the timing
Your timeline and flexibility matter, too. If you’re on a time crunch to sell that property before your hard money loan rate goes up, then accepting an offer with four contingencies probably isn’t the safest bet. In this case, a cash offer or offer with no (or very few) contingencies is best.
If you and your family are just putting out feelers and just want to be in a new home by next summer, then you’re likely a bit more flexible on timing. Just remember that contingent offers can always result in delays, so take this into account before moving forward.
Look at the offer’s big picture
Though the contingencies are important, you should also take a look at the offer as a whole. In some cases, there may be other aspects of the offer that make the contingencies worth it. Maybe they’re making an enormous down payment, so the financing contingency isn’t a big deal. Or maybe their earnest deposit is huge, ensuring you get compensated even if they pull out of the deal.
Sit down with your agent and look at the big picture of the offer before saying yes or no based on contingencies alone.
How’s the market?
Local market conditions can also come into play. If you’re selling your property in a buyer’s market or you’re not getting a lot of interest in the property, then you might need to accept contingencies in order to secure a sale.
If sellers have the advantage, on the other hand, then you can probably hold out for a better offer -- especially if you’ve had many people eyeing the property. Make sure you talk to your agent about the conditions in your local market, as well as what sort of interest your listing is seeing before making your decision.
How to protect yourself in a contingent offer
Accepting or denying a contingent offer aren’t your only options. You can also make a counteroffer and include some protections for yourself in the process.
Working in a kick-out clause, for example, can be a great way to reduce the risk that comes with contingencies, and it can help both you and the buyer get their way. Here’s how that works:
- You accept the buyer’s offer but can continue showing the home to other buyers while they attempt to satisfy the contingencies.
- If another buyer comes along with an acceptable offer, the original buyer gets what’s called “first right of refusal.” This gives them a short time period (usually 48 to 72 hours) to remove the contingency and close on the home.
- If they opt not to remove the contingency, you can accept the other buyer’s offer.
If you do go this route, make sure you ask for evidence of funds if the buyer removes the original contingencies. You want to make sure they’re really prepared to purchase the property before you turn down the new offer.
Another option? You can also ask for more earnest money. Since earnest money is nonrefundable if the buyer pulls out, it can give you some compensation for the extra risk.