Putting an offer on a home and going under contract is a major step toward making what is likely the biggest purchase of your life -- so it can be nerve-wracking when there are still unknowns, such as the condition of the home, its true market value and whether you'll remain financially stable through closing.
You have the option to protect yourself when you go under contract by making a contingent offer on a house. Contingency clauses are common in real estate contracts, and they can help protect you from loss of your escrow deposit or even a lawsuit should your real estate transaction fall through.
What Is a Contingent Offer?
A contingent offer on a home includes a clause that protects the buyer and makes it easier to back out of the deal without financial penalty in certain circumstances. Depending on the type of contingency specified, the buyer could have more power to renegotiate the price if the inspection reveals significant faults in the house, the lender rejects the mortgage application or the buyer is unable to sell his or her current home to free up cash for the down payment.
Types of Contingencies in a Home Purchase Offer
There are contingencies for a wide range of scenarios that can occur while a property is under contract, with one new type that addresses the effects of the COVID-19 pandemic.
Typically, only one or two contingencies are included in an offer, since a seller is less likely to be interested in a contract allows the buyer to back out too easily.
Here are five contingencies a homebuyer may include in an offer:
-- Coronavirus contingency.
-- Mortgage or funding contingency.
-- Home inspection contingency.
-- Appraisal contingency.
-- Sale and settlement contingency.
Coronavirus contingency. For homes that went under contract before stay-at-home orders went into place and unemployment rates skyrocketed nationwide, you won't find a contingency that factors in the pandemic.
"No contract in the country will contemplate for a pandemic of this nature, so off the bat, there will likely not be a clear out in the contract for a pandemic or health issues," says Pierre Debbas, partner and founding member of law firm Romer Debbas LLP in New York City.
But for those making an offer in the midst of the new reality of a global pandemic, that's changing. Coronavirus contingencies factor in the less-predictable effects the pandemic could have on the buyer's or seller's health, employment status or how the lender is able to finance the loan.
During these stressful times, a coronavirus contingency can help a buyer who is suddenly overwhelmed about unknowns in the near future. "It is to give the buyer a little bit more leniency if they want to walk away," says Annemarie Stephens, associate broker with Coldwell Banker Residential Brokerage in the District of Columbia.
Mortgage or funding contingency. The vast majority of homebuyers are only able to afford a home purchase with a mortgage. The National Association of Realtors reports that 86% of homebuyers financed their mortgage as opposed to paying cash, according to its 2020 Home Buyers and Sellers Generational Trends Report.
If you're worried about a lender denying approval for a mortgage, you may include a mortgage or funding contingency when you make an offer on a home to avoid losing your deposit should the deal fall apart as a result.
Home inspection contingency. A common contingency in a home purchase contract focuses on the results of the home inspection. Home inspections are often required by lenders, and many homeowners want them since they can uncover major issues with the house that aren't obvious.
If the home inspector finds cracks in the foundation or asbestos or mold, for example, the buyer will likely want to renegotiate the price or ask the seller to pay to fix the problem. If negotiations at this stage fall apart, the buyer can walk away.
During the pandemic, home inspectors are asking sellers, buyers and real estate agents to stay away during the inspection to avoid contact with other people. Inspectors are also trying to avoid touching additional surfaces as much as possible, and won't move objects or furniture to get to some normally examined spaces.
"If he can't get to the furnace, he won't get to the furnace," says Nan Smith, real estate broker for Baird & Warner in the Chicago metro area. If the inspection is incomplete as a result, a homebuyer may think twice about the deal.
Appraisal contingency. For homebuyers getting a mortgage, the appraisal is often a necessary step -- a bank doesn't want to provide more funding for a home than it's deemed to be worth. An appraisal contingency leaves room for the buyer to try to renegotiate the price if the appraisal comes in too low on the home. If the lender denies the mortgage based on the appraisal, the buyer could walk away from the deal.
These days, appraisers are trying to refrain from entering an occupied home for an appraisal. "They'll probably opt to just do a drive-by (appraisal)," Smith says. This includes using public documents, interior photos, details of recent renovations and an exterior examination of the property. Whether a drive-by appraisal is more forgiving than a standard appraisal is unclear and likely varies by appraiser and lender.
Sale and settlement contingency. Many homebuyers currently live in a property they own, and need to sell it in order to afford their new house. A sale and settlement contingency stipulates that the buyer must be able to sell a home before being able to close on the new property.
To make sellers more inclined to accept a sale and settlement contingency, the clause often allows the seller to keep his or her home actively for sale. If a better offer comes along while the buyer is still trying to sell her home, the seller can back out of the deal to move forward with the new offer.
With a settlement contingency, the buyer's purchase will only go forward as long as her sale closes. If the closing of her first home is delayed, the closing of her purchase will be delayed as well.
Because so many buyers need the profits from a home sale to be able to make the down payment on their next house, settlement contingencies may be a necessary part of many real estate contracts.
How Often Do Home Sales Fall Through?
Historically, the share of home sales that fall through before closing has been minimal. Real estate information company Trulia reported in 2017 that 3.9% of home sales failed in 2016, but little research has been dedicated to sale failures since.
Especially if you're a seller working with an experienced real estate agent, you're less likely to face issues with the inspection or appraisal, since the asking price should be close to its market rate determined in the appraisal and major issues with the house will have been fixed or disclosed prior to the inspection.
While there are certainly people who can no longer afford their down payment or have put off purchase plans until their employment is more stable, those who have gone under contract since the start of the pandemic appear eager to move forward. "I have not personally seen anyone trying to walk away," Stephens says.
When to Accept a Contingent Offer on Your House
As the seller, whether you accept an offer that includes a contingency depends on your willingness to endure the different circumstances that may arise.
Many sellers are willing to negotiate over repairs, come down slightly in price post-appraisal or wait to see if the buyer can sell a home before closing. You have the right to decline an offer based on contingencies you aren't willing to accept, however.
Homebuyer activity has dropped sharply during the COVID-19 pandemic, so sellers who are looking to close a deal now will likely need to be willing to accept a contingency or two.
Debbas says that condo developers looking to sell newly completed homes in New York City traditionally don't accept contingencies. Now, however, they're much more lenient. "If (you) want to try to conduct business during this pandemic, you have to adjust," Debbas says.
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