Buying a home is a transaction that involves many moving parts. Real estate deals can fall through for a number of reasons: A buyer may be unable to secure financing, a home inspection may reveal serious structural problems, or a home appraisal may come in far lower than expected. When the unexpected occurs, buyers may find that they’re on the hook financially for a property they no longer want or can afford.
Instead of hoping for the best, buyers have tools at their disposal that they can use to prepare for the unexpected. Contingent offers enable buyers to protect themselves financially. If you’re in the process of buying or selling a home, contingencies are something you should have a firm grasp on. Learn what contingent offers are and how they impact real estate transactions, so you can decide if you should make or accept one.
Contingent Offers In Real Estate
A contingent offer is an offer made on a property, which stipulates that specific conditions must be met in order for the sales contract to be binding. These contingencies, or stipulations, are typically set in place by the buyer to give them the opportunity to walk away from a real estate transaction without losing money in the event that something goes wrong.
A contingent offer, which must be accepted by the seller, is often made when the buyer is unsure that they’ll ultimately be able to obtain the funds they need to purchase the property. However, a contingent offer may also be made if the buyer is concerned that the property is overpriced or in poor condition.
How Do Contingent Offers Work?
When a buyer finds a property they want to purchase, they can write a contingency clause into the offer they make on the home. After the offer is made, it’s up to the seller to either accept the contingent offer, reject it or make a counteroffer that eliminates the contingency.
If the seller is willing to accept the contingent offer, they typically have two options. The seller can take their property off the market and hope that the condition stipulated in the contingency is met. Or, the seller can write a kick-out clause into the sales contract that enables them to keep their property on the market to see if a better offer comes along. If they receive a better offer, the seller must give the original buyer a chance to purchase the property within a specific window of time.
In most cases, real estate agents – and at times, attorneys – will help facilitate this process. A buyer’s agent will advise the buyer as to whether they should include a contingency, write up the offer and convey it to the listing agent (or FSBO seller). A listing agent will inform the seller of the offer, advise the seller as to whether they should accept the contingent offer and negotiate with the buyer’s agent (or buyer if they are not represented by an agent). Once the terms are accepted by both the buyer and seller, the contract is drawn up, and the parties eventually close on the home.
Types Of Contingencies
There are certain contingencies that home buyers commonly write into their offers: The mortgage contingency, home sale contingency, home inspection contingency and appraisal contingency. Let’s take a look at each one in more detail.
A buyer who requires a mortgage to purchase a property may choose to include a mortgage contingency clause in their offer. This contingency will enable the buyer to break the contract and walk away from the deal without losing their earnest money deposit if their financing is delayed or falls through.
While an accepted mortgage contingency will protect you in the case of financing setbacks, you should still get preapproved for a loan. Doing so will streamline the process and provide the seller with confidence that you’ll ultimately be able to obtain a loan large enough to cover the sales price of the home.
Home Sale Contingency
A buyer who does not need a loan but is reliant on the funds from the sale of their current home to purchase a new one may opt to include a home sale contingency clause in their offer. This contingency provides a buyer with a specific period of time to sell their home. If they cannot secure a buyer in that time, and therefore cannot obtain the funds necessary to purchase the new home, they are free to withdraw their offer and recover their deposit without consequences.
Home Inspection Contingency
After making an offer, it’s customary to have the home inspected. Sometimes, a home inspection can reveal serious, unexpected issues with the property that may affect the buyer’s desire to purchase the home or willingness to pay the price initially offered. With a home inspection contingency, buyers are provided with the ability to void the sales contract or renegotiate the offer. When renegotiating, a buyer has the power to insist that the seller makes repairs or lowers the purchasing price based on the cost of the work needed. If an agreement can’t be reached, the buyer again has the option to walk away.
Before agreeing to provide financing, lenders require properties to be appraised. They do this to ensure they’re not lending more money than a home is worth. When appraisals come in lower than the purchasing price, buyers are still on the hook for the agreed-upon price and must find a way to make up the difference. Unless, of course, they included an appraisal contingency in their offer, in which case buyers are able to break the sales contract if the home appraisal is the same price or higher than the purchasing price.
Other Important Terms To Know
Now that you have a deeper understanding of what each of these contingencies involves, there are some other important terms you should know. If you’re thinking of making or accepting a contingent offer, you’re likely to come across these terms as well.
When making an offer, buyers are typically required to put down an earnest money deposit. The earnest money (or escrow deposit) is provided upfront to demonstrate that the buyer is signing the contract in good faith and intends to purchase the property. Generally, the buyer loses this money if they pull out of the deal.
However, this isn’t the case when it comes to contingent offers. If the sale of a home is contingent on a particular condition that is not met, the buyer can break the contract and reclaim their earnest money deposit.
As mentioned earlier, when sellers receive a contingent offer, they can choose to write a kick-out clause into the sales contract. Also known as a release clause, the kick-out clause provides sellers with the ability to continue to market their home and accept back up offers in case the contingent offer falls through. This clause is important for sellers as it allows them to gain more control over the transaction. However, the kick-out clause also protects the initial buyer in that it includes the right of first refusal.
Right Of First Refusal
The right of first refusal provides the initial buyer the right to purchase the seller’s property before anyone else is allowed to. Therefore, if the seller receives an attractive offer from another buyer, the initial buyer has a certain period of time – often 72 hours – to remove the contingency and buy the home before it is offered to the new buyer. The ROFR is an important right for buyers, as it ensures that they can’t lose out on the property without warning.
A contingent offer that’s been agreed to by a seller is an accepted offer and updates the home’s listing status to “under contract.” Once all stipulated contingencies have been met, the status of the offer changes to pending. A pending offer simply means that the parties are preparing to close on the deal. Although pending offers usually only require further paperwork to be completed, real estate transactions still have the potential to fall through up until closing.
Benefits Of Contingencies
Contingent offers primarily benefit buyers, as contingencies provide them with a way out of what would otherwise be a binding agreement. By allowing buyers the opportunity to back out of contracts without financial repercussions, contingencies alleviate the stress of the unknown. Furthermore, buyers who are juggling the purchase of a new home while selling their old one, don’t have to pay for two mortgages at once.
Contingencies provide awareness that a deal has the potential to fall through, which is beneficial to sellers because it gives them the opportunity to prepare. The ability to write a kick-out clause into the contract means that sellers can continue to show their home and accept back-up offers as they wait to see if their initial deal closes. Sellers may even receive more attractive offers during this time, though they must still give their initial buyers the right of first refusal.
The Bottom Line
In situations where there are specific unknowns that buyers want to protect themselves against, contingent offers are a useful tool. By making contingent offers, buyers can sign otherwise binding contracts and not worry about suffering financial consequences if necessary conditions aren’t met.
However, if you are a buyer, you should be aware that sellers are often wary of accepting contingencies. If you’re buying a home in a seller’s market, there will likely be a lot of other buyers competing for the same properties. When the real estate inventory is low, choosing to include a contingency in your offer is risky, because the seller will likely reject it.
If you’re buying or selling a home and thinking of making or accepting a contingent offer, it’s a good idea to consult a real estate agent ahead of time.