Buying a home can be scary; you're committing to the largest purchase of your life, and decades of payments. As you get closer to signing on the dotted line, it's natural to start worrying about "what ifs." What if there's a hidden flaw with the home? What if it's not worth the price I'm paying? What if I can't sell my house, and I get stuck paying off two mortgages at once?
Luckily, there's a way that buyers can protect themselves against these kinds of bumps in the road. It's called a contingency. To put it simply, a contingency is a clause in a contract that states certain conditions must be met before the contract becomes binding. There are a lot of different kinds of contingencies, so let's go over how four of the most popular ones can benefit home buyers.
A Contingency Can Validate Market Value
One of the dirty little secrets of the real estate industry is that buyers and sellers don't actually have any idea what homes are worth. List prices represent what the seller hopes or wants, and offers represent what buyers are willing or able to pay. These numbers don't necessarily have any relationship to the objective appraised value of the home. In a situation this fraught with ambiguity, it's natural to worry that you might be overshooting the mark with your offer. That's what appraisal contingencies are for.
An appraisal contingency protects the buyer from overpaying for a home. It basically states that the buyer will go through with the sale, as long as a third-party appraisal confirms that the sale price is equal to or greater than the objective fair market value of the home.
So if that home you're about to buy for $200,000 is only appraised for $180,000, you can either back out of the sale with no penalty, or negotiate a lower price.
A Contingency Can Save You From Paying Two Mortgages at Once
Paying one mortgage is doable; paying two is tough. Ideally, you'd sell your present house right before you complete the purchase of your new one, so you can seamlessly transition from paying one mortgage to the next. But that's not always possible. There are a lot of moving parts in a home sale, and it's common for buyers to find themselves paying overlapping mortgages, which can be a real financial burden.
A home sale contingency is designed to prevent this situation. Basically, it states that the buyer will go through with the purchase once they've sold their own home. Obviously, this introduces a lot of uncertainty into the seller's situation, but it can be an easier sell than you think.
The home sale contingency is basically a bet on the buyer's present home selling quickly, so you'll want to make a convincing case to the seller that this is likely. Is the buyer's home competitively priced? What's the average time on market for their neighborhood? What are some comparable sales? The key is to paint a picture of an easy, quick sale, so the seller understands they won't be waiting around for weeks or months.
A key player here is the buyer's agent. They'll present this information to the seller's listing agent, who'll advise the seller on whether or not to accept the contingency. A persuasive agent with strong pre-existing relationships can be a huge help here.
Buyers should keep in mind that most sellers will ask for a "kick out" clause, which allows them to accept another offer as long as they give the initial buyer a window of opportunity, usually around 48 hours, to remove the contingency and close the purchase. So even if the seller accepts your home sale contingency, time is still of the essence.
A Contingency Can Ensure You're Buying a Quality Home
Savvy buyers know that no matter how pristine their dream home might look on the surface, it could still have problems. An inspection contingency is a way to protect buyers from being on the hook for a home that turns out to have serious flaws.
A typical inspection contingency calls for a home inspection, and lays out who's responsible for repairs, and a threshold at which the buyer can back out of the contract. Some common conditions are that the seller is responsible for repairs under $1,000, and that if the total repairs are equal to or greater than 2% of the sale price, the buyer can walk away.
So let's say the inspection on your dream home finds that one of the appliances is faulty. An inspection contingency can make sure that the seller replaces it before the sale. On the other hand, if the inspector finds a pest problem that's going to cost $5,000 to remedy, the buyer can either walk away, or negotiate a $5,000 price reduction. Either way, you're protected.
A Contingency Protects You In Case Your Financing Falls Through
A financing contingency simply protects you in case your financing doesn't come through, or if you don't get approved for the financing you want.
Let's say you put in an offer on a home for $200,000 with 20% down. That means you'll need $160,000 in financing. The contingency will likely state that if you don't get approved for financing, you can walk away from the sale without losing your earnest money. Alternately, it could also go into more detail about the exact kind of financing you find acceptable. For example, buyers can specify that they can walk away from the deal if they don't get a prime rate on their financing, which protects them from being locked in at an undesirable interest rate.
Financing contingencies can also benefit the seller, such as when it requires the buyer to apply for financing within a certain number of days. This protects the seller from foot-dragging and bad faith deals, which is really the point of all contingencies. Whether they seem to explicitly benefit the buyer or seller, contingencies are simply an acknowledgement that a home sale isn't a zero-sum game of who can exploit who, but, ideally, an honest, open transaction that benefits all parties equally.