Common Contingencies in Residential Real Estate Contracts
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Buying or selling a home can sometimes be a confusing process, especially when an offer contains contingencies. Below we’ll take a look at some of the more common contingencies in real estate transactions and what they mean for buyers and sellers.
What is a contingency in relation to buying or selling a home and how do they work?
A contingency in a home purchase or sale is saying that the buyer’s offer or the seller’s acceptance of a buyer’s offer is dependent upon something. For the offer to be accepted, the accepting party has to agree to the contingency set forth by the offeror. The offeree must be willing to accept the contingency for the offer to become a binding sales contract.
The most common contingencies
Buyer’s inspection contingency / option period
Unless you’re selling a house as-is, an option-period will almost always be a part of an offer you receive. The option period allows a buyer to schedule – at their own expense – any inspections they want done to ensure the home doesn’t have any unforeseen issues such as termites, roof problems, plumbing issues, etc.
Because inspections cost the buyers money, buyers don’t typically get them done until they have the home under contract. To compensate a seller for taking their home off the market temporarily for the option period an option fee is paid to the seller by the buyer.
A financing contingency is what it sounds like – the offer on the home is contingent upon the buyer getting approved for financing – aka a mortgage. This contingency is present in almost all residential sales contracts when a home is being sold to an occupant owner. Sellers can better protect themselves from having this contingency affect the sale by asking a potential buyer to submit a pre-qualification or pre-approval letter with their offer to show they’re likely to be approved for a mortgage for the home before accepting a buyer’s offer.
Other common contingencies
An insurance contingency means that the offer on the home is contingent on the home being able to be insured. This contingency is most common when a home has experienced significant damage before the sale. For instance, in Texas, there are homes that have flooded multiple times, which might affect the home’s ability to be insured.
When financing a home, a lender typically wants an appraisal of the property’s value to determine how much money they should loan on it to adequately protect their risk. Lenders base their loan to value ratios on the sales price or the appraisal price – whichever is lower. If Jack agrees to sell Jane his house for $100,000 and the appraiser says it’s only worth $80,000, the lender will only loan based on the $80,000 valuation.
If Jane chooses to go through with the purchase, she’ll need to bring the difference between the sales price and what the lender is willing to loan her based on the appraised value to the closing table in cash. In reality, most buyers can’t cover the difference in cash.
The appraisal contingency allows the buyer to walk away from the sale while still receiving their earnest money back should the buyer and seller not be able to come to new terms for the sales price based on the home receiving an appraisal value lower than the sales price – also commonly phrased as “if the house doesn’t appraise.”
Clear title contingency
A title is a document that details out the history of a property. Believe it or not, a title for a piece of property can be traced all the way back to the “Sovereignty of the Soil” – which is another way of saying since the title was first bestowed upon someone by the government.
A property’s “chain of title” not only tracks its history of ownership, but it will also follow any liens or financial encumbrances on the property, as well as any potential easements or agreements that are on public record for the property.
“Clear title” refers to proving that a) the person selling you the property has the right to sell it, b) that the only financial liens on the property are those known by the buyer, such as the sellers mortgage, and c) that there are no easements or agreements on file – such as someone having legal permission that survives the sale of a property to access the property at will.
Section 6 of the standard TREC residential sales contract covers the topic of title insurance, which it is highly recommended a buyer obtain when purchasing a home – and is something usually paid for by the seller in Texas.
Receipt of Seller’s Disclosure contingency
Most residential sellers are required by Texas law to provide a Seller’s Disclosure notice to prospective buyers. In the official TREC residential sales contract, Section 7(B) states:
Buyer has not received the Notice. Within ___ days after the effective date of this contract, Seller shall deliver the Notice to Buyer. If Buyer does not receive the Notice, Buyer may terminate this contract at any time prior to the closing and the earnest money will be refunded to Buyer. If Seller delivers the Notice, Buyer may terminate this contract for any reason within 7 days after Buyer receives the Notice or prior to the closing, whichever first occurs, and the earnest money deposit will be refunded to Buyer.
The Seller’s Disclosure tells a potential buyer about any defects in the home the current owner is aware exist. Once the Seller’s Disclosure is provided, the buyer has seven days to back out of the contract without recourse for the seller or a loss of earnest money.
Sale of another home contingency
This contingency means that the buyer can cancel the sales contract without recourse and receive their earnest money back in full if they’re unable to sell their current home by a specific date.
HOA rules contingency
Many homes are located within subdivisions with deed restrictions which are managed by a Homeowners Association or HOA. This contingency means that the buyer is requesting a copy of the HOA rules and their offer is contingent on receiving and accepting the HOA rules.
As an example – if John is self-employed and has a truck with a trailer he needs to park at his home when he’s not working, he might make his offer contingent on seeing and accepting the HOA rules. If upon receiving and reading the rules he finds they state that no trailers may be parked in driveways, John can back out of the purchase and receive a refund of his earnest money.
Slightly less common contingencies
Seller’s ability to find and purchase another home contingency
This contingency means that the seller can cancel the sales contract without ramification if they’re unable to find and purchase another home by a specific date.
Early occupancy agreements / late vacating agreement contingencies
These contingencies center around when the buyer can move into the home and when the seller must move out. An early occupancy agreement allows the buyer to move into and occupy the home before the official closing date where they will purchase the home. A late vacating agreement allows the seller to consider to reside in the home for a period after selling it to their buyer.
If an offer contains either one of these contingencies, it means the early occupancy or late vacation agreement is a condition of the offer. If the buyer or seller is unwilling to agree to that portion of the offer the rest of the offer becomes void.