Five important takeaway from this article:
- Real estate contingencies allow home buyers to back out of a deal.
- Common contingencies include inspection, appraisal, and financing.
- As a home buyer, you can choose whether or not you want to use them.
- Some buyers waive the inspection, appraisal or financing contingency.
- Losing your deposit is the main risk of waiving contract contingencies.
Over the past couple of years, we’ve seen an increase in the number of home buyers waiving contingencies for home inspections, appraisals, and even mortgage financing. This is a direct result of high competition within the real estate market, brought on by a lack of inventory.
But what does this mean exactly? How does a home buyer waive their purchase contract contingencies, and what’s the risk of doing so?
The short answer: The risk of waiving a mortgage, appraisal or home inspection contingency is generally the same. As a home buyer, you risk breaking the contract and losing your earnest money deposit, which could be thousands of dollars. So tread carefully.
For some buyers, particularly those in highly competitive housing markets, the risk of waiving contingencies is more of a necessity. They do it so they can compete in a multiple-offer scenario. For other buyers, the risk of waiving contingencies isn’t worth it. This is especially true for those who cannot afford to lose their earnest money deposit.
Risk of Waiving Contingencies: A Lost Deposit
Before we go any further, we need to talk about what a real estate contingency is. After all, you can’t fully understand the risks of waiving contingencies until you understand how they work.
In the context of a real estate contract or purchase agreement, a contingency is a future event that must happen in order for the deal to proceed.
For example, if a home buyer includes an inspection contingency within their purchase agreement, it gives them the right to back out of the deal due to some kind of negative findings. More importantly, the inspection contingency allows the buyer to retain their earnest money deposit.
In other words, they can back out of the deal without losing any money.
When waiving a contingency, on the other hand, the home buyer runs the risk of breaking the contract and losing their earnest money deposit. That’s the key takeaway from this article.
There are several different types of contingencies included within purchase agreements. Today, we will talk about three of the most common scenarios. We’ll look at the risks of waiving contingencies for a home appraisal, an inspection, and mortgage financing.
The Home Appraisal Contingency
A home appraisal is when a licensed appraiser determines the market value of a particular property. Mortgage lenders almost always require home appraisals to be conducted, before they will fund a real estate purchase. They do this to make sure they are not lending more than the house is actually worth.
A home appraisal contingency says that if the house appraises for less than the agreed-upon purchase price, the buyer can back out of the deal without losing their deposit.
If the house appraises for an amount equal to or greater than the agreed-upon purchase price, there’s no issue. The mortgage lender will likely fund the deal based on the appraiser’s findings.
But if the appraisal “comes in low,” it can throw a wrench into the works. In this scenario, one of three things can happen:
- The seller can reduce the sale price.
- The buyer could request an additional appraisal.
- The buyer can pay the difference out of pocket, via the down payment.
- The buyer can back out of the deal, due to the low appraisal.
This is where the contingency comes back into the picture. If a home buyer chooses to waive the home appraisal contingency, backing out of the deal will probably cost them their earnest money deposit. That is the primary risk of waiving an appraisal contingency. It means you could lose your upfront deposit, which might equal thousands of dollars.
On the other hand, a home buyer who includes an appraisal contingency could back out of the deal without losing their deposit. (As long as it’s written that way in the purchase agreement.)
The Home Inspection Contingency
Unlike an appraisal, which is focused on the market value of the house, the home inspection evaluates the current condition of the property.
The inspector will review all aspects of the home being purchased, including the roof and foundation, the electrical system, heating and air conditioning, etc. The home inspection is the buyers’ way of learning the true condition of the house they’re attempting to buy.
Some buyers choose to include a home inspection contingency within their purchase agreement. Other buyers might decide to waive the inspection contingency, in order to make their offer more appealing to the seller.
As with the previous scenario, the primary risk of waiving a home inspection contingency is that you could lose your earnest money deposit by violating the contract’s terms.
In its simplest form, the home inspection contingency gives the buyer the right to back out of the deal if the inspector discovers something they are uncomfortable with. For example, if the inspector says there are serious problems with the foundation, the buyer could choose to exit the deal while retaining their earnest money.
Without such a contingency in place, the buyer could risk losing their deposit by backing out of the deal due to inspection-related concerns. In this scenario, the buyers haven’t given themselves an “exit strategy.”
The Mortgage Financing Contingency
Last but not least, we have the mortgage financing contingency. This clause states that if the home buyer cannot obtain mortgage financing within a specified period of time, they can exit the deal while retaining the earnest money deposit.
Many home buyers get pre-approved for a mortgage loan before they start shopping for a house. This allows them to narrow down their search to a specific price range, saving time and energy. A mortgage pre-approval letter can also make sellers more inclined to accept your offer.
But it’s important to realize that mortgage pre-approval does not guarantee financing. Things can still go wrong along the path to funding. In some cases, a mortgage underwriter will find problems that prevent the loan from going through, despite the pre-approval. This is when a home buyer might benefit from using a mortgage loan contingency.
These contingencies state that the home buyer must be able to obtain mortgage financing within a certain period of time, for the deal to go through. If something happens with the borrower’s home loan approval, this contingency allows them to back out without sacrificing the earnest money deposit.
You might have noticed a pattern here. In all of these real estate contingency scenarios, the primary risk of waiving a contingency is the same. You could be risking whatever amount of money you paid in the form of an earnest money deposit.
Understand Your Local Real Estate Market
We’ve covered the biggest risks of waiving an appraisal, inspection or mortgage contingency. In all cases, the home buyer risks losing their earnest money deposit, if they back out of the deal for some reason.
That’s the whole point of these real estate contingencies. They make the purchase offer dependent or “contingent” upon certain events and conditions.
So you might be wondering why someone would choose to waive a contingency in the first place. It usually comes down to local real estate market conditions.
In a highly competitive real estate market, waiving an appraisal or mortgage contingency could mean the difference between offer acceptance — or rejection.
Think about it from the seller’s perspective. In a competitive market, the seller will have multiple offers to choose from. So they might have the luxury of choosing the “cleanest” offer, meaning the one with the fewest contingencies.
A contingent offer can make things more complicated for the seller, when compared to an offer that has zero contingencies. This is why some home buyers are willing to accept the risk of waiving the appraisal, inspection, or mortgage financing contingency. They feel that they have to do this, in order to compete with other offers.
Ultimately, the choice is yours. There is no law that requires you to use or waive real estate contingencies. The purchase agreement is a legal contract between you and the seller. So it’s up to both parties to tailor the document until it meets their needs.
Disclaimer: This article provides a basic overview of the risks associated with waiving real estate purchase contingencies. It is not meant to serve as legal advice. We are not recommending “for or against” the waiving of contingencies, but merely providing the information you need to make an informed decision.
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author