What are contingencies in real estate? How to protect your real estate investment in 2022
With the housing marketing remaining extremely hot, buyers find themselves in a tough spot. Getting an offer accepted now means locking in a reasonable interest rate, which is expected to rise over the next few years. However, it also means paying well over asking and waiving their standard protections.
Many home buyers are feeling urgency caused by record-high demand and low supply. With rents and interest rates rising, many people are trying to become homeowners. But in this crazy competitive market, many sacrifices are being made - such as contingencies.
So what are contingencies, and how do they protect buyers? In this article, we’ll cover everything you need to know about real estate contingencies. Real estate contingencies are an essential part of making an offer on a home.
What is a real estate contingency?
A contingency is a clause added to a contract that gives the buyers the option to back out without penalty if certain conditions are not met. When a buyer makes an offer on a home, they can add a contingency.
A contingency says that the buyer won’t buy the house for the agreed price if XYZ doesn't happen. So, for example, an inspection contingency allows the buyer to change their mind if the property has any issues.
However, this doesn’t mean that they won’t buy the house. Instead, it typically means they would like to renegotiate the terms of the agreement - usually the closing price.
Contingencies are an excellent way for buyers to protect themselves. Many buyers are waiving their contingencies to make their offers more competitive. While this does make sellers more likely to accept their offer, it also exposes buyers to risk.
Here, we’ll explain some of the most common contingencies in real estate and what happens when you waive them.
What are the most common types of contingencies?
1. Home inspection contingency
A home inspection contingency clause on a property offer requires a home inspection result before the deal is closed. A home inspection is a visual examination of a property, where a licensed inspector assesses the condition of the home’s essential systems and structures. Including:
- Floors and ceiling
- Doors and windows
- Plumbing and electrical systems
With a home inspection contingency, buyers can renegotiate the price based on discovered repair needs. It also lets them back out of the deal if the seller is unwilling to renegotiate.
While inspections don’t cover everything, they are a great way to help buyers understand the home's condition. By waiving an inspection contingency, you waive your right to negotiate the final cost based on the inspection by waiving an inspection contingency.
It's important to know that 86% of inspections find something wrong with the home. While there isn’t always something major, you commit to purchasing the home for full-price and funding any needed repairs. This means you’ll be paying more out of pocket and accepting liability for any repairs that need to be done.
If you want to make your offer more competitive, be sure to consider the property's age when choosing to waive your inspection contingency. Older homes typically have more significant (and more expensive) issues than newer ones, exposing you to more risk.
2. Financing contingency
A financing contingency adds a condition on your housing offer that the deal can’t be closed unless you secure financing, typically a mortgage.
In October 2021, financing issues contributed to 20% of delayed real estate contracts and 9% of terminated real estate contracts. COVID-19 showed just how volatile the economy could be and the ability to earn income and secure loans with it.
If you put an offer on a new home, a financing contingency shouldn't be waived if you are using a loan of any kind. However, if you are paying with all cash, you won’t need to worry about this.
Some companies out there give you a cash loan, giving you the same power as a cash buyer. They typically let you close faster and can eliminate the need for a financing contingency (this is not financial advice).
3. Home sale contingency
A home sale contingency is an offer dependent on whether the buyer can sell their current home or property before an agreed-upon date. This applies when the buyer is trying to sell their existing home and buy a new one.
Home sale contingencies typically occur when the buyer cannot afford a second mortgage. When getting pre-approved for a loan, the lenders will indicate that they are willing to lend, but only if the buyer closes out their current mortgage.
If the buyers cannot sell their current home for whatever reason, they can back out of the sale and retain their earnest money.
This is a contingency that, if necessary, most buyers cannot get out of. However, some companies will help sellers buy a new house before selling their current home.
4. Appraisal contingency
An appraisal contingency is an expert evaluating the market price of a property. Mortgage lenders typically require appraisals. To protect the lender in the event of a default, the lender will take possession of the property.
Since the property is used as collateral for the loan, the lenders want to ensure the property value will cover the loan amount. If the property is worth less than the buyer offered, the lender will not cover the full amount.
By adding an appraisal contingency, you can renegotiate the closing price based on the appraised value. This protects you from paying more for the house than it is worth.
Without an appraisal contingency, you may end up needing to cover the difference between the appraised value and offered price. For example, if the appraised value is $250,000, but you offered $275,00, you could pay an extra $25,000 out of pocket.
Worst of all, the $25,000 does contribute to your downpayment or closing costs. The extra cash goes directly to the seller and does not count toward your home equity.
5. Title Contingency
A title contingency lets you withdraw your offer if there are legal issues regarding the property ownership. This contingency grants the buyer the right to review a title report, which documents the home's ownership history.
This contingency allows a buyer to go through any potential agreements on record. For instance, if the property they want to buy comes with a shared driveway and the contract does not explicitly state who is responsible for its maintenance, you can clarify before purchasing the home.
What are the risks to waiving contingencies?
In October 2021, 23% of buyers waived the appraisal contingency clauses, and 21% of buyers waived the home inspection contingency clause.
While waiving these contingencies can make your offer more attractive to a seller, it also raises the risk for you. Waiving a home inspection contingency, for example, might cost you in the long run. If the property has issues or damage that need repairing, you'll end up paying for those repairs out of pocket.
Contingencies are put in place to protect the buyer. Waiving them can subject the buyer to significant risks that they need to understand before waiving the contingency.
If you are looking to buy a house now, you’ll end up needing to make some compromises. Home buying demand is at a record high, and with interest rates rising, many buyers want to find a home quickly.
While waiving contingencies is never ideal, it may be necessary to win an offer in today's market. The important thing is that you understand the risks you expose yourself to and prepare accordingly.
The bottom line
Buying a home is one of the most significant milestones in most people’s lives. However, it’s essential to do your part to ensure your investment is protected. Remember to do your research, be informed, and be prepared to invest time to find the perfect home.
We hope you found this article informative and if you have any questions, feel free to comment below or reach out to us directly!