The Most Common Contingencies in Real Estate

When you buy or sell a home, it often comes with contingencies. A contingency is a condition that must be met before an agreement between two parties can proceed. In a home sale, it means that the buyer's offer or the seller's acceptance of a buyer's offer is dependent upon certain things, considered contingencies, and these must be met before the purchase can close. If a contingency is not met, the parties can back out of the deal with no financial repercussions.

Below are the most common contingencies in real estate transactions and what they mean for buyers and sellers.

Buyer's Inspection Contingency / Option Period

Unless a buyer purchases a house as-is, the option period is usually part of their offer. This takes place after the seller accepts the buyer's offer and is a short time window for the buyer to schedule and cover the expense of a home inspection.

A home inspector assesses the house for structural issues, roof damage, and other problems, and this protects the buyer from potential problems and major repairs the house may need. If the inspection report shows existing issues, the buyer can ask the seller to cover the cost of repairs, or the buyer can back out of the deal.

Financing Contingency

With a mortgage, most buyers would be unable to purchase a home. This is where the financing contingency comes in, as it specifies to the seller that the buyer's offer is contingent upon the buyer being approved for a mortgage.

Sellers can protect themselves from having a financing contingency ruin the sale by requesting that potential buyers submit a mortgage pre-approval letter with their offer. This letter assures the seller that an underwriter has already reviewed the buyer's financials, the buyer can afford the home sale price, and their mortgage is likely to be approved.

Appraisal Contingency

Before a buyer is approved for a mortgage, their lender will require a home appraisal to ensure they aren't issuing a loan for more than what the home is worth. An appraiser examines the property and comparable home sales in the area to determine its fair market value.

Lenders base their loan-to-value ratios on the sale price or appraised value whichever is lower. If the sale price is $100,000 and the appraiser says the home is worth $80,000, the lender will issue the buyer's loan based on the $80,000 valuation. With an appraisal contingency, the buyer has three options in this scenario:

1. The buyer can negotiate with the seller to lower the sale price so they can proceed with the purchase.
2. The buyer can pay the difference between the sale price and appraised value - $20,000 - in cash at closing. But the reality is that most buyers cannot cover the difference.
3. The buyer can cancel the sale and get their earnest money deposit back.

Sale of Another Home Contingency

Most buyers can't afford to carry two mortgages simultaneously, which is why the home sale contingency exists. It's a clause that states the buyer won't go through with the purchase until their current home is sold within a specified period usually one to two months.

If the buyer's current home does not sell within that period, they may be able to extend the contingency's time frame with the seller's permission. But if the seller doesn't want to wait any longer, both parties can walk away from the deal, and the buyer gets their earnest money back.