Ideally, we’d like to work in a real estate industry in which everybody wins. Easier said than done. But contingencies, when used in good faith, help us get closer to that goal. What are contingencies? Basically, they’re conditions that can be placed on a transaction that, if not met, invalidate the transaction. This definition probably paints more of an “everybody loses” scenario than one in which everyone wins. But contingencies are commonplace in the real estate industry because they actually work. And one reason they work is because they have a definitive endpoint. A contingency period provides a finite amount of time for the parties to complete their contingencies. Contingencies can work in everyone’s favor. Parties can also abuse them to the detriment of a transaction. The more you know about them, the better your chances of using them for the good of all involved.
How Both Sides Benefit from Contingencies
Some agents see contingencies as panic buttons that can nuke an entire transaction. But they’re actually a safeguard that keeps all sides working together ethically. Any negative reputation is likely due to a contingency’s tendency to dilute an offer. But most buyers are hesitant to enter a transaction without an eject button in the case of an emergency. It’s important to remember that contingencies are negotiable, so no one is signing up for something with which they don’t agree. Deals can be finetuned to compensate for contingencies. And when we’re dealing with transactions as colossal as property sales, it would be crazy to not have contingencies as an option.
Types of Common Contingencies
Contingencies come in all shapes and sizes, though there are a few that pop up more frequently than others. Agents are more likely to come across the following common contingencies in a standard transaction:
Appraisal Contingency
Would you buy a home without an independent appraiser’s inspection? If you answered “no”, you’re one of many prospective buyers who would employ an appraisal contingency. A buyer can continue through a transaction confidently with this kind of contingency in place. It can also ease lender concerns if they feel a buyer is at risk of overpaying for a property.
Though an appraisal contingency hinges on a professional opinion, it is an opinion nonetheless. This means different appraisers can calculate different figures. If an appraisal determines a home’s value is below the stated purchasing price, the buyer typically holds the right to terminate the transaction. Of course, the appraiser must conduct their review within the contingency period.
In many cases, a buyer will still want to purchase a property, even if the listing price is above the appraised value. Lenders won’t loan more funding than a property is worth, so it’s up to the buyer to come up with the extra cash or work out a reduced price with the seller. In any case, a contingency does not automatically terminate a transaction. It does however provide an escape option for both parties if they fail to complete the contingencies.
Mortgage/Loan Contingency
A mortgage contingency (also referred to as a loan contingency) takes into account the need for adequate funding when purchasing a home. There’s always the chance that a lender could deny a loan rendering a transaction difficult to complete. Rather than continue to be legally responsible for the purchase, the buyer can use this contingency to safely back out of the transaction. This type of contingency typically requires the longest contingency period.
Home Inspection Contingency
This contingency may seem similar to an appraisal contingency, but their objectives are different. Sure, a home inspection contingency triggers said inspection. But there’s no valuation tool used in this inspection. In this case, the third party inspector is looking for unreported defects. If the inspector finds significant defects within the contingency period, the buyer can legally back out of the transaction.
Home Sale Contingency
Buyers can even safeguard themselves by adding the sale of their home as a condition required to complete the transaction. Referred to as a home sale contingency, it reinforces the buyer’s financial capabilities of affording their desired home. If their home fails to sell, they can exit the transaction without legal repercussions. This type of contingency benefits the seller too. Since it is reliant on the constraints of a contingency period, the seller is free to move on to the next offer if the buyer cannot meet their own terms in the allotted time.
How a Contingency Period Keeps a Transaction in Motion
Obviously, contingencies can’t go on indefinitely. Therefore, the parties agree upon a contingency period to ensure all inspections and the like complete in a timely manner. The duration of a contingency period can vary per contingency. Parties can also negotiate a longer or shorter duration. In California, if a party doesn’t clearly state a contingency period’s duration, it typically defaults to 17 days. Upon the seller’s acceptance of the buyer’s offer, the contingency period for any proposed contingencies begins.
Completing a Contingency
A contingency is completed either by satisfying the condition or at the conclusion of the contingency period assuming there is no dispute. Here in California, a contingency is not officially completed until the buyer submits a contingency removal form. If a buyer fails to submit a contingency removal form by the close of the contingency period, the seller reserves the right to terminate the transaction. However, the seller is also required to submit a notice to perform to the buyer prior to seeking termination. A notice to perform gives the buyer an official notice to complete any contingencies or officially proclaim their intent to terminate the contract. The buyer can also opt to remove their requested contingencies and move forward with the transaction.
It’s important to note that serving a notice to perform can be regarded as a hostile action. If a seller still wishes to proceed with the transaction, they may wish to diplomatically reach out to the buyer. This way, they can potentially renegotiate the terms of the contract. But when a notice to perform is issued, the buyer must act and do so quickly. This can prompt a termination of a transaction.
A terminated transaction is obviously not the outcome either side wants when entering a contract. In most cases, contingencies are designed to make sure both sides are getting the most from their shared transaction. And with an agreed upon contingency period in place, contingencies shouldn’t delay a transaction long. But it is often up to a skilled agent to keep things running smoothly through clear communication. A little finesse can ensure that all parties walk away smiling.
