Personal Finance

How Contingency Clauses Can Impact Your Home Purchase

Name: Article on what contingency clauses are and how they affect home purchases
Brand: Axos Bank

Oct 12, 2022

Buying a house is a big financial commitment – and you never know what potential expenses will be uncovered after you’ve settled in.

It’s for this reason that contingency clauses exist in real estate contracts. But when you’re in a hot real estate market, it may be tempting to waive the contingencies to move your offer to the top of the stack.

Keep reading to learn more about contingency clauses and how they can impact offer acceptance.

What is a homebuyer contingency clause?

It’s a provision in the home purchase contract that states what terms must be met for the contract to proceed. This creates a safeguard for buyers and sellers, helping to make sure everyone is comfortable as the sale progresses.

Typically, if a sale is cancelled due to an unmet contingency, the buyer gets back their earnest money (also known as a good faith deposit). This makes it legally and financially possible to walk away from the home.

There are also contingency clauses that protect the seller. For example, they can write into the contract the ability to continue to market the home and collect back-up offers in case the sale is cancelled.

What are common contingencies and how do they impact your offer?

It’s nice having a built-in safeguard. But when there are multiple offers on the table, the seller may pass over yours for one with fewer strings attached. This is true whether the market is hot or cooling off – especially if the offer is contingent upon the sale of another property.

Ultimately, you need to submit an offer that makes you comfortable, even in a hot market. “Every scenario is different. As a buyer, it’s important to know what you can and can’t do or how risk tolerant you are,” explains Justin Santolaya of NextHome Bella Properties. “It’s a case-by-case scenario and it’s an important conversation to have with your agent.”

Here are some of the most common homebuyer contingencies.

1. Loan Contingency

This is also known as a financing or mortgage contingency. It specifies the amount of time a buyer has for securing financing to buy a home.

When to waive: If you need a loan to close the deal, then you’ll want to include this contingency in your offer. But if you’re able to pay for the home without a loan, then you can certainly waive this contingency.

How to lessen the impact: Entering into the offer with a fully underwritten preapproval is a great way to lessen the effect of this contingency. It provides the seller confidence that your financing will come through.
2. Appraisal Contingency

With an appraisal contingency, the property must appraise for at least the indicated sales price – a common requirement by mortgage lenders to ensure the buyer meets loan-to-value ratio (LTV) requirements.

When to waive: You could consider forgoing this contingency if you’re making a cash offer. If you’re getting a mortgage to finance the property, you could waive the contingency if you have enough cash to close the gap should the appraisal come up short.

How to lessen the impact: You can minimize the impact of an appraisal contingency if you include the seller’s ability to reduce the price to the appraised value instead of canceling the sale.
3. Inspection Contingency

This contingency often includes physical inspections as well as reviewing disclosures, title report, homeowners association (HOA) documents including CC&Rs (Covenants, Conditions, and Restrictions), and Natural Hazard Disclosure (NHD) reports.

When to waive: Don’t! As Santolaya shares, “There have been many cases where a buyer waived their inspection and ended up with a property with severe problems, unknown easements, or modification restrictions due to HOA policies or CC&Rs.”

“An experienced Realtor® will be on the lookout for problems and restrictions. However, it’s crucial to have an out should any red flags arise.”
– Justin Santolaya, Realtor® at NextHome Bella Properties

How to lessen the impact: Work with your real estate professional to identify other ways to strengthen your offer. This could include covering some of the typical seller costs or bumping up the amount of your offer.

You can also minimize the contingency by eliminating the physical inspection requirement. Conduct an inspection during the initial showing. “Depending on your agent’s relationship with a preferred home inspector, some inspectors are happy to join you when you first see a home,” says Santolaya. “But be sure to keep the contingency that relates to disclosures and title in play until those are reviewed thoroughly.”
4. Home Sale Contingency

This states the buyer needs to sell their current home by a certain date to proceed with the purchase. It’s the contingency that’s most likely to cause an offer to be passed over.

“Due to the low supply and high demand, sellers are rarely interested in waiting for a buyer to close on their existing home,” says Santolaya. “In most cases, it’s best for them to move on to a buyer who’s ready to close quickly.”

When to waive: Eliminate this contingency by seeking a bridge-to-sale loan. A bridge loan is short-term, covering the purchase of a new property while your existing home is being sold. It alleviates the “buy before you sell” dilemma and allows you to drop the home sale contingency.

How to lessen the impact: If a bridge loan isn’t an option, work with your real estate professional to identify other ways to strengthen your offer. Or focus on selling your existing home and rent back from the buyers while you shop for your next property.
5. Homeowners Insurance Contingency

This provision stipulates the buyer must apply and qualify for homeowners insurance. Insurance is required by mortgage lenders, so it’s important that the property is eligible for coverage.

When to waive: It’s not recommended to waive this unless you’re paying with cash and are comfortable covering the costs if there’s a large disaster. This is especially true if the property is in a high-risk area due to natural disasters or is an older property.

“One of the most common situations we run into in Southern California is when the property lacks updates and is located in a hard-to-place area due to potential wildfires,” says William Lemmon of Broadway Insurance Services. “Finding coverage for a home that’s out of date is substantially more difficult.”

How to lessen the impact: If the seller hasn’t experienced issues obtaining coverage, then they’ll likely view this contingency as a minimal risk. Seek recently updated properties and ask about permitted updates, including the roof, electrical, plumbing, and heating source.

Be Home Offer Ready

If you’re starting on a homebuying journey, Axos Bank is here to help. Check out our library of home loan articles. Then, let us know if you have questions. Our team of mortgage experts is ready to walk you through the homebuying process so you can purchase with confidence.