What is a Contingency, and is it Appropriate to Waive it?
Deniz Kahramaner is the Founder & CEO of the data-driven Real Estate Brokerage Atlasa. His mission is to help home buyers understand the tradeoffs of different home options using big data and analytics.
Feel free to contact Deniz if you need help with the home buying or selling process at email@example.com.
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What is a contingency?
A contingency is “a clause that buyers include when making an offer on a home that allows them to back out of buying the house if the terms of the clause aren’t met.”
Contingencies allow buyers to drop out of a contract for various reasons based on which contingency they have decided not to waive. If the buyers were to “drop out,” they would not lose the earnest money deposit, which is typically 3% of the purchase price.
If a buyer has waived their right to have contingencies (aka a non-contingent offer) and isn’t able to close escrow, their 3% security deposit could be at risk.
What types of contingencies are there?
The three main types of contingencies are the following:
An inspection contingency allows a specific amount of time (however many days you prefer but appropriate) to inspect the property and understand its condition.
Common scenarios include:
- While it is common for Bay Area listing agents/sellers to provide home and pest inspection reports for buyers before getting into a contract, there are cases where they still need to. Bringing in your own licensed inspectors will help you understand what may or may not need to be replaced or fixed.
- When the home inspector suggests further inspections in the report. It would be appropriate to call specialists, including but not limited to:
- Structural engineers
- Soil specialists
These inspections must be done in a timely manner within the inspection contingency period, as it takes time to schedule available specialists and generate reports in some cases.
Depending on the findings:
- You can waive your contingencies, keep the purchase price as is, and close escrow.
- You can use this opportunity to have the seller fix the issues or renegotiate the purchase price.
- You can drop out of escrow and get your security deposit back because of the inspection contingency clause.
A loan contingency is used when the buyer has yet to undergo the process with a mortgage lender to get pre-approved and fully underwritten for a home loan prior to getting into contract. This contingency allows the buyer more time for the bank to approve a loan.
Common scenarios include:
- Waiting until the last minute to begin conversations with the mortgage lender when a property you love has an upcoming offer deadline. It takes time for lenders to deep dive into your financials to determine your eligibility — typically up to 2 weeks.
- Working with not-so-well-known and unreliable lenders who provide attractive low rates. Bad lenders can hold up the process despite your best efforts to stay on top of them, which is why it is best to chat with different lenders in the initial stages.
We typically recommend getting preapproved and/or underwritten before writing an offer to make your offer stronger in comparison to others. This does not mean that your offer will not be accepted with a loan contingency, but it could be perceived as a riskier offer to the sellers. There is always a chance that the offer falls through during the loan contingency period if the buyer cannot secure financing, which typically results in the property being relisted on the market with the risk of being perceived as “sitting or the market” or stale.
An appraisal contingency is included in the offer if the buyer worries that the property will appraise at a price that is less than what they offered for it. The bank can only loan up to the lower appraised value.
Common scenarios include:
- When a buyer’s offer is accepted at a seller’s firm an unreasonably high price.
- When a bidding war occurs in a hot market amongst buyers with loan offers.
These scenarios create a situation where the appraiser assesses that the value of the home compares to similar home sales in the area, NOT the higher offered price.
When this discrepancy occurs, a buyer has 3 options:
- You can make up the difference in cash if you want to close escrow.
- You can renegotiate the purchase price with the seller. The sellers have the right to stand firm and not negotiate.
- You can drop out of escrow and get your security deposit back because of the appraisal contingency.
Other Types of Contingencies
Contingencies can be specific as detailed within the “Contingency Removal” form. They can also be laid out as additional terms by the buyer.
Additional contingency examples include:
- Review of Disclosure Documents — If certain documents are missing from the disclosure package, you can add a contingency to receive and review those documents. This can include the build permit records, HOA docs, seller docs, etc.
- Title — If the title is not “clear” so to speak, a buyer can add in a title contingency that gives the buyer the right to “raise any objections to the status of the title of the property, which must be cleared by the seller in order for the purchaser to close on the transfer of title”
- Sale of a Prior Home — In some situations, buyers must sell their current property to afford a new home. This contingency allows that buyer a certain amount of time to sell that property before closing on the new one.
- Homeowners Insurance — Home insurance is becoming harder to get in specific areas for various reasons such as earthquake, flood, and fire risks. That said, knowing if your property is covered by insurance before purchasing is important. This contingency allows the buyer to ensure that it is possible and allows them the right to withdraw from the contract if they are unable to do so. This could be required by the mortgage lender or the seller.
Does a contingency weaken or strengthen my offer? And why would I want a contingency?
This question is hard to answer as it depends on your location. As mentioned prior, inspections are not provided in some areas. This means that contingencies are normal and frequent in almost every offer. This is common in LA and San Diego County.
In my experience, the Bay Area historically provides inspections, and contingencies are typically waived, especially when the market is extremely competitive. When comparing a contingent offer to a non-contingent offer, the non-contingent offer is “stronger” since it does not add the risk of the buyer dropping out of the contract.
This does NOT mean that you must be non-contingent in the Bay Area. Offers with contingencies are accepted as well, and you, the buyer, must feel comfortable with your decision if you were to want to waive or not waive contingencies. I am there to provide guidance based on your risk tolerance.
Here are some cases in which a contingent offer is likely okay in the Bay Area:
- If you are the only offer
- If the property is sitting
- If there are no inspections
- If you need to acquire financing
- If you feel as if the property may not appraise at the price at which you are paying
What happens if I waive contingencies?
If you waive contingencies, it means that you agree to the terms and conditions of the contract as laid out by the sellers.
In the event you wish to drop out of contract, by removing contingencies that allow you to verify the property’s condition and/or any details of the property, you forfeit your 3% earnest money deposit.
Whether you want to waive contingencies or not, you need to know what it means and what you’re comfortable with.
Finding the right home is a necessary process that can take a significant amount of time. An average buyer will have to sift through an incredibly large amount of paperwork, documentation, and stress. Rather than losing too much hair over obstacles between you and your dream home, don’t be afraid to seek help. At Atlasa, we aim to guide you through the buying process so that you get a quality home that meets your standards.
If you are entering the buying or selling process, know that Atlasa has the real estate industry expertise and the transparent work ethic to find the right seller or buyer for you. We pay attention to details and don’t overlook the things that matter. To get in contact with an Atlasa realtor about your current or future home, contact us now at firstname.lastname@example.org.
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Deniz Kahramaner is the Founder & CEO of the data-driven Real Estate Brokerage Atlasa. His mission is to help home buyers understand the tradeoffs of different home options using big data and analytics. Feel free to contact Deniz if you need help with the home buying or selling process at email@example.com.