Purchase Contract Contingencies Give You an 'Out' When Buying a Home
Summary: This article provides a definition of the purchase contract contingency, and also explains some of the most common types of contingencies used by home buyers.
As a buyer, you'll eventually reach a point where you have to make an offer on a house. The offer will be presented in the form of a purchase agreement, also known as a contract. This is one of the most important documents you will encounter during the home buying process. So you need to understand everything that goes into it, and that includes contingencies.
The Primary Parts of a Purchase Contract
At a minimum, the real estate purchase contract will include the following items:
- The mutually agreed-upon sale price
- Earnest money deposit
- Property address and description
- Terms of the sale
- Date of final walk-through
- Date of closing
- Home buyer's contingencies
It is the last item we will focus on in this tutorial. Specifically, we will examine the different types of contingencies that can be included in a real estate purchase agreement, and why they are so important to you as a home buyer.
What Is a Contingency?
The dictionary defines a contingency as "a future event or circumstance that is possible but cannot be predicted with certainty." That's an accurate definition for home buying contingencies, as well. When you include these items in a purchase contract, you are essentially giving yourself a way to back out of the contract if a certain event or circumstance occurs.
Here's another way to think about it: A real estate contingency is a condition that must be met in order for the deal to go through. It is a requirement for the completion of the sale.
For instance, if there is a home inspection contingency written into the sales contract, it means the buyer has a right to back out of the deal if the inspector finds serious problems with the house. So the sale is contingent upon the buyer's acceptance of the inspection results.
In this example, the inspection is the "future event or circumstance that cannot be predicted with certainty," as stated in the definition above.
Common Real Estate Contingencies
There is no limit to how many purchase contingencies you can put into your sales contract. The document itself is mostly boilerplate and standardized. But, as a home buyer, you could attach as many real estate contingency items as you want. It might make the seller less inclined to accept your offer, which is something to consider. But it is your legal right to include them.
Here are some of the most common purchase contingencies home buyers include within their contracts:
- Home Inspection -- This is one of the most common types of real estate contract contingencies, and with good reason. It's sort of a no-brainer. We talked about the home inspection contingency earlier. It gives home buyers a legal "out" if they are unhappy with the results of the inspection. Minor deficiencies, such as a leaky faucet, can be repaired by the homeowner prior to closing. Other items might be more severe and harder to fix, like a major foundation crack. This contingency allows you to back out of the deal if you're not comfortable with something uncovered during the inspection process. We recommend that you include this one, at a minimum.
- Financing -- This is another common type of purchase contract contingency. Most home buyers use mortgage loans to cover the cost of their purchase, or at least a big chunk of it. The problem is that mortgages can "fall through" somewhere between the purchase agreement and closing. The buyer gets pre-approved for a loan and makes an offer on a house. The seller accepts the offer. A week later, the mortgage lender's underwriter finds a problem with the application file, and the loan is denied. It happens. In such cases, the buyer would want a way out of the purchase contract. That's what a financing contingency does.
- Sale of Current Home -- This provision makes the sale contingent (or dependent) upon the successful sale of the buyer's current home. If the buyer is unable to sell his/her current property, they have a legal way out of the purchase contract. As you can imagine, sellers are reluctant to accept this type of offer, and typically only do so as a last resort. In a competitive market where buyers are competing for limited inventory, this type of purchase contract contingency can work against the buyer.
- Home Appraisal -- Mortgage lenders use home appraisals to make sure the property being purchased is worth the amount the buyer has agreed to pay. In some cases, the home will appraise for less than the purchase price. A home appraisal contingency gives you a chance to renegotiate the purchase price to reflect the appraisal, or to back out of the deal entirely.
- Clear Title -- The title is a legal document that shows who has owned a home in the past, and who currently owns it. It is the official history of ownership. During a typical home-buying scenario, a title company will check the title to make sure it is "clear" of liens, disputes or other issues. Some title issues can be resolved between the purchase agreement and the final closing. Others can be more problematic. Title contingencies give buyers a way out of the contract, in the event of unresolvable issues.
Note: These are not the only contingencies that can be included within a real estate purchase agreement. But they are some of the most common inclusions.
A Double-Edged Sword
Real estate contingencies are a double-edged sword for home buyers. They give you a legal way to back out of a transaction, if some unforeseen event occurs. That's a good thing.
But they can also make your offer less appealing to the seller, especially in a hot market where multiple offers are common. That's the downside. Market awareness should be your guide.
Certain types of purchase contingencies are common and should not raise any red flags with sellers. The home inspection contingency is a good example, as is the mortgage financing clause. Most real estate contracts includes these two provisions, and for good reason. They're common sense. But the further you get away from these common contingencies, the more likely the seller is to object.
For instance, making the sale contingent upon the sale of your current home could work against you -- especially in a seller's market where the homeowner could have plenty of other offers to choose from.
Bottom line: It's wise to use certain types of purchase agreement contingencies when buying a house. They prevent you from getting "trapped" into buying a home you either don't want or can't afford. But you have to exercise good judgement when including these clauses in your contract. One contingency too many, and the seller might reject your offer.