As you may know by now, a lot can go wrong in a real estate transaction. Sometimes the buyer can’t secure financing on time, or the home inspection reveals defects that will be costly and burdensome to repair. Long before these situations can arise, it can be very beneficial to add contingencies to real estate contracts.
Contingencies in real estate help protect buyers and sellers from being bound by a contract they can no longer uphold or don’t wish to uphold. The following is a list of possible contingencies in real estate. We’ll define the real estate contingencies and provide an example of each contingency type. First, we’ll discuss what real estate contingencies are. Next, we’ll explain the elements of a real estate purchase contract. Read on for everything you need to know about common contingencies!
What Are Real Estate Contingencies?
According to Eric J. Martin of Bankrate, “A contingency refers to a clause in a real estate purchase agreement specifying an action or requirement that must be met so that the contract can become legally binding. Both the buyer and seller must agree to the terms of each contingency and sign the contract before it becomes binding.”
Contingency clauses are meant to “safeguard buyers and sellers by giving them the right to cancel a contract if the terms aren’t met,” says Carlos Del Rio, a real estate attorney in Chicago.
On the FortuneBuilders blog, Paul Esajian warns that “They can also work as a double-edged sword. While these stipulations may further protect investors from mistakes, they can also hurt the negotiation process. The overuse of contingencies can overwhelm sellers in some cases and ultimately hurt the completion of a deal. Investors must understand how to adequately incorporate contingencies. The number will vary; the right combination will depend on both the type of deal, the fine print, and all parties involved.”
Elements of a Real Estate Purchase Contract
Most real estate contracts for residential properties consist of 7 different elements.
- The agreed-upon sale price for the property
- The final walkthrough date
- The closing date
- The agreed-upon amount for the earnest money deposit
- A description of the house and its address
- Sale terms
Several contingencies may be included in a real estate purchase contract, and there are specific requirements and time limits for each type. Read on to discover general contingency rules and types of real estate contingencies. We’ll start with the most common contingencies in real estate and move on to less common ones.
Contingency Rules for Real Estate Contracts
There are several prerequisites that must be met before real estate deals are completed. Contingencies must be stated in specific ways and care must be taken to word them appropriately. Here are some examples:
- Contingencies must be conditional. The validity of the contract depends on whether tasks are completed or avoided.
- Contingencies must be specific and measurable. If the real estate contingency is not specific enough, it cannot be adequately enforced. The contingency must be direct enough to be enforceable.
- Contingencies must have deadlines. Deadlines prevent parties from becoming confused by the contract. The closing process is time-sensitive and the transaction process should finish in a timely manner. This helps hold both parties accountable and ensures that the process goes as smoothly as possible.
- The contract must be binding. When contracts are official and binding, the contract requires that parties fulfill their obligations under the contract as long as each condition is met. Contingencies should be clearly stated so that both parties will know what to do should a dispute arise.
The Buyer Must Secure Financing
The first contingency we’ll cover is the financing contingency for a real estate contract. This is also called a mortgage contingency clause. So what is a mortgage contingency? According to Erik J Martin, “This clause specifies a window of time in which the buyer must obtain financing to purchase the home. If the buyer doesn’t secure a loan by that deadline, they can withdraw from the deal without penalty and the seller can put their home back on the market and choose a different buyer.”
This is one of the best contingencies in real estate because it is mutually beneficial. If the buyer doesn’t get financing in time, they won’t want to be “on the hook” for a property they may not afford, and the seller will be relieved to know that they can put their home back on the marketing the seller can’t get financing, without repercussions.
Sample Financing Contingency for Real Estate
This sample was found on the Law Insider website in Section 22:
“Buyer’s obligations under this Agreement are contingent upon Buyer obtaining, no later than forty-five (45) days after the Effective Date, a binding commitment for financing to be secured by a first mortgage or deed of trust against the Real Property in an amount and terms reasonably acceptable to Buyer. The failure of Buyer to notify Seller by the end of the forty-five (45) day period that it has obtained the binding commitment shall be deemed a failure of this contingency and this Agreement will, in such event, be automatically terminated and the Deposit paid to Seller without further action required by either party. Buyer shall use good faith efforts to obtain financing conforming to the terms of this Paragraph.”
The Inspection Must Not Reveal Issues
The home inspection contingency addendum (also known as the option clause) grants the buyer a window of time in which to get the property professionally inspected. After the inspection, the buyer will be provided an inspection report. The buyer may move forward with the property purchase, request repairs to the property, or request that the seller lower their asking price.
Buyers usually pay a small amount (called an option fee) so that they can terminate the contract should severe issues arise during the inspection. The option fee is more widespread in Texas than in other states, but it can and may be used in other states as well. The inspection contingency ensures that buyers can walk away from the contract without losing their earnest money deposit and is a favorite of buyers. During the option period, the seller can continue to negotiate and accept backup offers from other potential buyers.
Inspection Contingency Examples
“Buyer’s obligation to purchase is contingent upon Buyer’s inspection and approval of the condition of the property.
Another from Law Insider reads:
“On or before the date that is thirty (30) days after the Effective Date, TRMC shall deliver to TLO written notice of (a) TRMC’s satisfaction or waiver, in TRMC’s sole discretion, with respect to the results of the inspection contingency stated in this Section 4, or (b) the failure of this condition. If TRMC fails to timely deliver such C – 4 notice to TLO, then this condition shall be deemed not satisfied, and TRMC shall be under no obligation to proceed with the repurchase of the Marine Crude Storage Facility. If TRMC’s inspection contingency followed the exercise of the Right of First Refusal, then following TLO’s receipt of notice of the failure of this inspection contingency by TRMC (or TRMC’s failure to timely deliver the required notice to TLO), TLO shall be free to sell the Marine Crude Storage Facility to the third party submitting the Purchase Offer on the Purchase Terms, and TRMC’s Right of First Refusal, and TLO’s obligation under this Agreement, shall be null and void and without further force or effect. If TLO fails to enter into a Purchase and Sale Agreement with the third party submitting the Purchase Offer on the Purchase Terms, or thereafter the transaction fails to close, then TRMC’s Right of First Refusal shall continue in accordance with the terms of this Agreement for so long as TLO owns the Marine Crude Storage Facility. If TRMC timely notifies TLO of the satisfaction of this condition, then TRMC shall deposit into escrow, with First American Title Insurance Company or such other title insurance company as is satisfactory to the parties (the “Title Company”), an amount equal to two percent (2%) of the Repurchase Price, and the parties shall proceed to close the repurchase transaction within sixty (60) days thereafter.”
The Title Must Be Clear
Usually, a title company or the buyer’s attorney reviews the title on the home before closing. They will also resolve issues so the title can be transferred to the buyer free and clear. Sometimes, problems come up with the title process and they aren’t resolved by the time the sale closes. Buyers can use a title contingency to review a title report, which lists the history of ownership for the home. It will also let the buyer know if there are any shared areas that they will be responsible for maintaining.
Sample Title Contingency Clause
Here is a Title Contingency Clause that was on Law Insider:
“The County’s purchase of the Property is subject to the County’s approval and satisfaction of a preliminary title report to be delivered to it by Seller. The County’s purchase of the Property is further contingent on the Seller’s ability to provide title to the County that is free from liens and encumbrances.”
The Appraisal Must Be Similar To the Asking Price
According to Investopedia, “An appraisal contingency protects the buyer and is used to ensure a property is valued at a minimum, specified amount. If the property does not appraise for at least the specified amount, the contract can be terminated, and in many cases, the earnest money is refunded to the buyer.” A home appraisal contingency is another protection for buyers, to ensure that the home is really valued at its set price.
We wanted to include a couple of appraisal contingency clause examples, so we’re providing an example of the TREC Appraisal Contingency in Texas and a Florida Appraisal Contingency Addendum.
TREC Appraisal Contingency
Common Appraisal Contingency Addendum in Florida
This appraisal contingency was found on Highlight Realty’s website:
“This Contract is contingent upon Buyer obtaining, at Buyer’s expense, a written appraisal from a licensed Florida appraiser, stating that the appraised value of the Property is at least $_______________ (if left blank, the Purchase Price), on or before ______________________. If the appraisal states that the appraised value of the Property is less than the above value, Buyer shall deliver a copy of such appraisal to Seller within 3 days after the above date and deliver written notice to Seller, either: a) terminating this Contract in which event the Deposit paid shall be refunded to Buyer, thereby releasing Buyer and Seller from all further obligations under this Contract; or b) waiving and removing this contingency and continuing with this Contract without regard to the appraised value of the Property, except as provided in Paragraph 8(b) if it is checked.
“If Buyer fails to timely obtain an appraisal, or having timely obtained such appraisal fails to timely deliver notice of Buyer’s exercise of the right to terminate granted above, this contingency shall be waived and removed, and Buyer shall continue with this Contract, without waiving any of Buyer’s rights in Paragraph 8(b) if it is checked.”
Less common clauses include a homeowner’s insurance contingency, which “stipulates that the buyer must apply for and obtain homeowners insurance on the property, and if they can’t get the necessary insurance, either party can withdraw from the contract. This clause is often requested by either the seller or the mortgage lender,” according to Bankrate. Another contingency that’s often requested by sellers is the kick-out clause, which, according to Quicken Loans, “is a type of contingency in the purchase agreement. Sellers may be able to give the buyer a certain amount of time – usually 72 hours – to drop the contingency and proceed with the sale. If the buyer can’t make it happen within that amount of time, the seller can kick them out of escrow.”
Which Contingencies Should Be Included?
So what contingencies should be included in a purchase contract? That’s going to depend on your knowledge of the buyer and seller, and the market conditions. Know your market and communicate openly with all parties and you’ll know exactly what contingencies may be needed for a purchase contract.
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Sean started his career at the Boston Consulting Group, where he met his wife. They live in Chicago with their son, London. Sean graduated The Wharton School with honors.