Having a Back-Out Plan: Why You Need Contingencies

You’ve finally done it.  You studied the market, looked for months, and found the home of your dreams.  You’re excited and ready to proceed.  You write your Purchase Agreement, and immediately come upon the language of contingencies.

A contingency is a provision in a real estate contract that specifies that the buyer would have the right to cancel the contract, without penalty, upon the occurrence of a certain event. (For example: “This contract is contingent upon Buyer successfully obtaining a mortgage loan at an interest rate of 6% or lower.” Should rates rise quickly, and this rate no longer be available, the buyer could elect to proceed, or to cancel the contract based on his/ her contingency.)  You go into the purchase, hoping for the best, but planning for the worst.  And if something unforeseen occurs, your contingency is the method by which you may exit the contract.

When you’re buying a home, Plan A is for you to buy the home on the terms in the original contract. Plan B occurs when you discover unforeseen defects and your desire is to buy the home after renegotiating some of the terms. Plan C is the contingency plan: If there is an incurable defect in the condition of the home, the home doesn’t appraise for the purchase price, or your lender refuses to fund your loan for whatever reason, you can back out of the transaction without losing your deposit, (other than the money you’ve spent on appraisal, inspections, and any incidental fees) as long as you have the appropriate contingencies in place.

When you’re in an active seller’s market, or there are multiple offers on a property, you might be tempted to make an offer with no contingencies, or one with no appraisal or loan contingency.  You need to carefully weigh the consequences of having no back-out plan on your purchase. This is too large a purchase to be without an escape route, at least until your investigations into the condition of the property are completed. Unless you are pre-approved for your loan, and that the property will appraise at full value, you should not forgo your rights by waiving your financial contingencies.

The results of your home inspections will help you decide whether you need to cancel your home purchase. As a general rule, properties that look very well maintained have usually been very well maintained. Over the last decade, though, a wave of buying and rehabilitating, or “flipping”, properties strictly for profit (not to live in) has taken over in Los Angeles. (Think Jeff Lewis of Bravo fame.) This is especially true in areas where investors have purchased bank owned foreclosures or short sales and flipped them for profit. In an effort to maximize profit, some investors pay all their attention to cosmetic detail, and very little to the structural integrity of the home, while others literally tend to everything from the ground up. Check into the history of the home you are buying, before you write your offer.  And remember that with any property, looks can be deceiving, and for this very reason, you need contingencies.

If you are competing with other buyers for the property, you can shorten your contingency period so that the seller can gain certainty that you will close the transaction sooner, rather than later, if you get a good report from the physical inspector, the appraiser, and the lender.  But consider all options carefully before you forego your contingencies; they are truly the buyer’s safety net.