What Is A Contingent Offer, And Why Is It Used When Buying A House?
Miranda Crace7-minute read
November 07, 2022
Real estate transactions have a lot of moving parts and home sales can fall through at any moment. However, home buyers can protect themselves from the unexpected with a contingency. But what exactly does this mean?
Let’s look at the different types of common contingent offers on a house, how they work and why you might make one when making an offer on your dream home.
What Is A Contingent Offer In Real Estate?
A contingent offer is a bid that a seller accepts on their home, but the final sale is dependent on specific criteria the buyer sets. If the contingency is not satisfied, the prospective buyer can back out of the sale and reclaim their earnest money deposit.
Most contingencies fall under three main categories in a purchase contract: appraisals, home inspection and mortgage approval. Contingencies like these are put in place so a buyer can cancel a real estate contract if something goes wrong at a specific point in the home closing process.
You shouldn’t avoid contingencies because, just like homeowners insurance, they’re a normal part of the home buying process. Your real estate agent can help you determine which contingencies you should include that will still present an attractive offer to sellers.
Home Inspection Contingency
A home inspection contingency is essential when you are making a home purchase, and you should never waive them under any circumstances.
These inspections are also known as due diligence contingencies, and give the buyer the right to have the home’s interior and exterior inspected by a professional home inspector. Usually, the inspection must be done within a specific period, like 5 – 10 days.
This inspection protects the buyer from purchasing a home that has issues and allows them to cancel the contract, negotiate repairs or request an additional inspection based on the home inspector’s findings.
What’s A Cost-Of-Repair Contingency?
A cost-of-repair contingency is a requirement that specifies the maximum dollar amount given for repairs that are considered necessary. A buyer might already have one in place as part of the contract.
Ordinarily, they are included in the inspection contingency and are based on a specific sales price percentage, like 1%.
If the inspection report shows that repairs will cost more than the maximum dollar amount allowed, then the buyer can back out of the contract.
The appraisal contingency is used to make sure the property is valued at a minimum amount.
Generally, the buyer or mortgage lender has a third party come in to determine the home’s fair market value. If the property doesn’t appraise for at least the specified amount, the contract can be terminated. This contingency clause protects the buyer, and in most cases, the sellers will refund the earnest money if the agreement is canceled due to a low appraisal.
Home appraisal contingencies can also include terms that allow the buyer to purchase the home even if the appraisal is below the specified minimum amount.
The buyer could then request that the seller lower the asking price of the home to match the appraisal amount. However, if you are getting a mortgage on your home, the lender might only cover the estimated cost if your home appraises for lower than what it’s worth.
For example, let’s say you have a loan that will cover 90% of the cost of the home, and you have to put down 10%. If the house costs $250,000 before the appraisal, you’ll have to make a $25,000 down payment.
If the house appraised for $225,000, the lender would still only cover 90% of what the house actually appraised for, which means you would now have to come with a down payment of $47,500 to purchase the home.
Low property appraisals are a common reason that mortgages don’t get approved, so the appraisal contingency is a critical part of your contract and shouldn’t be waived.
A mortgage contingency, also known as a financing contingency, is a clause in the purchase agreement that states the offer depends on the buyer securing financing to purchase the home. Its primary purpose is to protect both parties by giving the potential buyer the time to obtain their financing.
If the buyer is unable to secure financing from a bank or mortgage broker, they can back out of the contract and get their earnest money back. The seller is protected by this contingency because it ensures they don’t end up with a buyer who can’t purchase the home.
This contingency will also state a specific number of days the buyer is given to obtain financing. The buyer must pay attention to this period because the contingency can be waived if they don’t terminate the contract before that time. If this happens, even if you can’t obtain the funding, you would still be financially obligated to purchase the property.
Prepare Yourself For The Mortgage
You must have a good credit score so that you can get a loan preapproval before you start looking for a new home. The worst thing you can do is find a home that you can’t get approved for.
To prepare your credit for buying a home, you should:
- Know your current FICO® Score: There are several places online that will give you a free credit check. However, you want to focus on your FICO® Score when it comes to getting a mortgage.
- Lower your credit utilization: Credit utilization is a huge factor when it comes to your credit score. You should be paying down as many credit cards as possible so that this factor can help increase your score. The lower your utilization is, the better your credit score will be, and the lower your loan’s interest rate will be.
- Have at least three accounts older than 6 months: Customarily, a lender will want you to have a few tradelines on your account, and they want to see a history of at least 6 months. This combination helps with your average age of accounts and also your credit mix.
- After your preapproval, freeze your credit: You wouldn’t believe how many people get denied for their loan right before they are about to close on their home. You want to be sure that nothing new hits your credit, so doing a credit freeze until you close is a great idea.
Home Sale Contingency
A home sale contingency is put in a sales contract when buyers must sell or settle their current home to finance the new house. The contingency will state terms regarding the specific time the buyer has to sell their home, and if the buyer sells their home by that date, the contract moves forward.
If the home doesn’t sell, the contract is terminated, and the buyer can get their earnest money back. A home sale contingency will be the most difficult for the seller because they might have to pass up any additional offers while they are waiting for the buyer’s home to sell.
There are two different types of home sale contingencies: sale and settlement contingency and settlement contingency.
Sale And Settlement Contingency
A sale and settlement contingency is used when the buyer has not received or accepted an offer on the home they are currently selling. Usually, this type of real estate contingency allows the seller to keep marketing their home to other buyers.
However, it does come with the stipulation that the buyer can remove the contingency within 24 – 48 hours of the seller receiving another buyer’s offer.
If the first buyer is still unable to remove the contingency at that time, the contract is terminated, and the seller can choose a better offer from other home buyers. The original buyer will also receive their earnest money back.
A settlement contingency is used when a buyer has received or accepted an offer on the home they are currently selling and has a closing date on the calendar. This contingency will protect the buyer in case the sale of their current home doesn’t finalize.
Typically, this type of contingency won’t include a kick-out clause, which allows the seller to keep marketing their home to other buyers. That means if the seller accepts a contingent offer with a settlement clause, they won’t be able to continue showing their home.
As long as the buyer’s home closes on the date listed in the offer, the contract will remain valid, but the agreement can be terminated if the house doesn’t close on time.
How Often Do Contingent Offers Fall Through?
Most offers on a house contain some type of contingency and a recent study by the National Association of REALTORS® (NAR) found that only 6% of real estate contracts were terminated in July 2022. That means it’s a fair assumption that most contingent purchase agreements are successfully carried out and don’t fall through.
NAR also noted that some buyers are still waiving contingencies to stay competitive in the current real estate market, but doing this can increase the risk for both parties. Remember, the sale can still fall through. If you’ve waived contingencies and you back out of a sale due to a low appraisal or a major home flaw, you can lose your earnest money.
The Bottom Line
A ton of work goes into closing on your home, and each small step clears the way for your most important purchase. These common contingencies are set in place to protect the buyer and seller so both are happy with the purchase agreement.
Whatever you do, don’t waive these contingencies for any reason. You’re better off losing the home of your dreams than buying a money pit.
Contingent offers are just one way to protect yourself as a home buyer. Start your mortgage application process today and discover what homes you can afford.
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