After my recent post, “Having a Back Out Plan: Why You Need Contingencies”, I had a lot of questions from first time buyers asking for a more in depth description of the various contingencies in the purchase contract. So what are contingencies?
Contingencies are clauses in a real estate contract that stipulate various conditions that must be met by the buyer and the seller for completion of the purchase. They provide a sort of road map to the transaction: as each contingency is met and fulfilled, another hurdle to the transaction is passed.
For Buyers, contingencies are important because, should they be unable to fill the obligations of the contract, or should they decide that they no longer want to purchase the property if the physical condition is not as anticipated, they are provided a means to withdraw from the purchase without penalty. These are not a “get out of jail free” card; Buyers and Sellers must act in good faith, and have bona fide grounds under the contingency to be released from their responsibilities under the terms of the contract.
Some Buyers may be tempted make an offer without contingencies in order to make their offer look more appealing to the seller. Especially when there are multiple offers on a property, the buyer 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 offer. 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.
Below are some of the more prevalent buyer contingencies that are written into contracts, and some you may want to consider writing into your own contract should you think about purchasing a home:
Currently a 17 to 21 day contingency period. Buyers who obtain a loan will be required by the lender to pay for an appraisal to substantiate the purchase price. Sometimes, a low appraisal is received. If the appraisal does not match the purchase price, the buyer may a) have the property re-appraised; b) renegotiate the price with the seller; c)make up the difference with additional cash; or d) withdraw from the purchase without penalty
- Loan Contingency.
Currently a 17 to 21 day contingency period. Even though a buyer may hold a loan pre-approval letter, further investigations concerning the property or the borrower could result in a loan denial. In addition, the loan contingency protects the buyer from a rise in interest rates. This contingency gives the buyer a way to withdraw from the contract without penalty if an application for financing is denied, or if financing is granted for a lesser amount (say, if the home appraises for less than expected) or at a higher interest rate or points.
- Home Inspection.
Usually a 7 to 14 day contingency. Buyers have the right to hire a home inspector and conduct a complete inspection of the home. In addition, if the initial general inspection turns up additional findings that require more specialized inspections, the buyer is entitled, under the inspection contingency, to bring them in as well. The buyer may, based upon the findings of their inspections, a) issue a Request for Repair from the Seller; b) request a credit for necessary repairs from the Seller; c) withdraw from the purchase without penalty. If buyers issue a Request for Repair, the seller is entitled to receive a copy of the home inspection.
- Roof Inspection.
This investigation is done as a part of the Buyer’s Home Inspection, and is covered in the time period as listed, above. Many home inspectors will not walk on a roof due to possibility of damage and / or liability if the roof is damaged. Some buyers hire a roofing company to conduct a roof inspection.
- Sewer Inspection.
This investigation is done as a part of the Buyer’s Home Inspection, and is covered in the time period as listed, above. Sewers can get clogged from tree roots or deteriorate over time. Plumbing inspection companies insert a camera into the sewer line to check for damage during a sewer inspection.
- Private Well Inspections.
If the home is not connected to city water — on a private well, buyers may want assurance that the water is potable and meets acceptable health standards.
- Radon, Mold or Asbestos Inspections.
This investigation is done as a part of the Buyer’s Home Inspection, and is covered in the time period as listed, above. Depending on a visual inspection, sometimes home inspectors will call for additional inspections by licensed entities to check for special situations such as radon gas, mold or asbestos.
- Lead-based Paint.
Federal laws gives all buyers 10 days to inspect for lead-based paint. Many homes built before 1978 contain lead-based paint.
- Wood Destroying Pest Inspection.
The contract should specify who will pay for the pest inspection, whether outbuildings or garages are covered in the inspection, and whether the work will be completed, and who will pay for the termite completion (work). This may be done in the purchase agreement, or in a separate addendum. Once the inspection is performed, the buyer has the right to review the findings, based on the terms specified in the purchase agreement.
- Early Occupancy Agreements.
Contracts can be contingent upon the buyer and seller entering into a written agreement that allows the buyer to rent the property prior to close of escrow. This is known as early buyer possession. A separate written rental agreement is written for the protection of the parties.
- Preliminary Title Report
Must be delivered to the buyer, usually within 3 to 7 days from acceptance of offer. Title investigations will disclose easements, CC&Rs, and monetary liens of record, including the ability of the seller to transfer clean title the buyer. The buyer’s title insurance policy protects you from anything not discovered during that preliminary investigation.
- Homeowner Association Documents.
This contingency normally runs for 7 to 14 days. Buyers should obtain for approval a copy of all homeowner association documents, including meeting minutes, if applicable.
- Seller Statutory Disclosures.
Must be delivered to the buyer, usually within 3 to 7 days from acceptance of offer. Sellers are required in California to disclose all known material facts, including preparing and delivering a Transfer Disclosure Statement (TDS), Natural Hazard Disclosure Statement, special taxes and statutory supplemental and, if requested, a seller property questionnaire.
- Contingent on Selling Existing Home
Buyers who have an existing home might want to buy before selling and make the contract contingent on selling their home. Unless the market is tending heavily in favor of the Buyer, Sellers will not usually accept this contingency. Sellers who accept contingent offers like this often give the buyer a certain number of days to perform, usually 14 to 30 days. If the Buyer cannot perform, the Seller retains the option to cancel the contract. The Seller will often retain the right to continue to market the property, and accept back-up offers. Those offers are accepted with the contingency below.
- Contingent on Cancellation of Existing Escrow
Sellers who accept the above Contingency of Sale often accept other offers during the Buyer’s contingency period. Those “back up” offers contain a contingency that provides for the second (or third or fourth) Buyer’s purchase to proceed only when the Seller’s first escrow has canceled. This prevents the Seller from being in jeopardy by selling his home to two or more Buyers at the same time.