Purchase Contract Contingencies Give You an 'Out' When Buying a Home
5 key points from this article:
- Purchase contract contingencies give home buyers a way to back out of a real estate contract and "walk away" from the deal.
- Most purchase agreements are contingent upon a satisfactory home inspection and mortgage financing approval.
- There are other types of contingencies as well, in addition to the most common ones mentioned above.
- Buyers should use a "market-minded" approach when adding these items to their contracts.
- Making a purchase agreement contingent on too many things could turn the seller off, especially in a hot real estate market.
As a home buyer, you'll eventually reach a point where you have to make an offer on a house. The offer will be presented in the form of a purchase agreement, also known as a contract.
This is one of the most important documents you will encounter during the home buying process. So you need to understand everything that goes into it, and that includes contingencies.
The Primary Parts of a Purchase Contract
Let's start with the different parts of a standard purchase agreement. At a minimum, residential real estate contracts typically include the following items:
- The mutually agreed-upon sale price for the home
- Earnest money deposit amount and related specifics
- Property address and description
- Terms of the sale
- Date of the final walk-through
- Date of the closing
- Home buyer's contingencies (if any)
Today we will focus on the last item on this list. We will examine the different types of purchase agreement contingencies that can be added to a real estate contract, and why they are so important to you as a home buyer.
What Is a Purchase Contract Contingency?
The dictionary defines a contingency as "a future event or circumstance that is possible but cannot be predicted with certainty." That's an accurate definition for home buying contingencies, as well.
When you include these items in a purchase contract, you are essentially giving yourself a way to back out of the contract if a certain event or circumstance occurs. For this reason, contingencies are sometimes referred to as "walkaway clauses." They let you walk away from the deal, legally.
Here's another way to think about it: A real estate contingency is a condition that must be met in order for the deal to go through. It is a requirement for the completion of the sale.
Example: If there is a home inspection contingency written into the purchase agreement or sales contract, it allows the buyer to back out of the deal if the inspector finds serious problems with the house. In this common example, the sale is made contingent upon the buyer's acceptance of the inspection results.
Here, the inspection is the "future event or circumstance that cannot be predicted with certainty," as stated in the definition above.
Common Real Estate Contingencies
There is no limit to how many purchase contingencies you can put into your sales contract / purchase agreement. These documents are mostly boilerplate and standardized. As a home buyer, you could attach as many real estate contingency items as you want. It might make the seller less inclined to accept your offer, which is something to consider. But it is your legal right to include them.
Here are some of the most common purchase contingencies home buyers include within their contracts:
- Home Inspection Contingencies -- This is one of the most common types of real estate contract contingencies, and with good reason. It's sort of a no-brainer. We talked about the home inspection contingency earlier. It gives home buyers a legal "out" if they are unhappy with the results of the property inspection. Minor deficiencies, such as a leaky faucet, can be repaired by the homeowner prior to closing. Other items might be more severe and harder to fix, like a major foundation crack. This contingency allows you to back out of the deal if you're not comfortable with something uncovered during the inspection process. We recommend that you include this one, at a minimum.
- Mortgage Financing Contingencies -- This is another common type of purchase contract contingency. Most home buyers use mortgage loans to cover the cost of their purchase, or at least a big chunk of it. The problem is that mortgages can "fall through" somewhere between the purchase agreement and the final closing. The buyer gets pre-approved for a loan and makes an offer on a house. The seller accepts the offer. A week later, the mortgage lender's underwriter finds a problem with the application file, and the loan is denied. It happens. In such cases, the buyer would want a way out of the purchase contract. That's what a financing contingency does.
- Sale of Current Home -- This provision makes the sale contingent (or dependent) upon the successful sale of the buyer's current home. If the buyer is unable to sell his/her current property, they have a legal way out of the purchase contract. As you can imagine, sellers are often reluctant to accept this type of offer and might do so only as a last resort. In a competitive market where buyers are competing for limited inventory, this type of purchase contract contingency can actually work against the buyer. But in a slower market, sellers might be more inclined to accept such an offer.
- Home Appraisal -- Mortgage lenders use home appraisals to make sure the property being purchased is worth the amount the buyer has agreed to pay (at least). In some cases, the property will appraise for less than the purchase price. A home appraisal contingency gives you a chance to renegotiate the purchase price to reflect the appraisal, or to back out of the deal entirely.
- Clear Title -- The title is a legal document that shows who has owned a home in the past, and who currently owns it. It is the official history of ownership. During a typical home-buying scenario, a title company will check the title to make sure it is "clear" of liens, disputes, or other issues. Some title issues can be resolved between the purchase agreement and the final closing. Others can be more problematic. Title contingencies give buyers a way out of the contract, in the event of unresolvable issues.
Note: These are not the only contingencies that can be included within a real estate purchase agreement. But they are some of the most common inclusions.
A Double-Edged Sword
Real estate contingencies can be a double-edged sword for home buyers. They give you a legal way to back out of a transaction, if some unforeseen event occurs. That's a good thing.
But they could also make your offer less appealing to the seller, especially in a hot market where multiple offers are common. That's the downside. Market awareness should be your guide.
Certain types of purchase contingencies are common and should not raise any red flags with sellers. The home inspection contingency is a good example, as is the mortgage financing clause. Most real estate contracts includes these two provisions, and for good reason. They're common sense. But the further you get away from these common contingencies, the more likely the seller is to object.
For instance, making the deal contingent upon the sale of your current home could work against you -- especially in a seller's market where the homeowner has other offers to consider.
We encourage buyers to take a "market-based" approach when using purchase agreement contingencies. Spend some time researching your local real estate market. Is there a lot of competition from other home buyers? Are houses selling fast with multiple offers, or are they "sitting" on the market for a long time? Understanding local market dynamics will help you determine which purchase agreement contingencies to include -- and which to leave out.
Bottom line: When buying a home, it's wise to make the contract contingent on certain conditions. This can help you avoid becoming "trapped" into buying a house you either don't want or can't afford. But you have to exercise good judgment when including these clauses in your purchase agreement. One contingency too many, and the seller might reject your offer.