Contingencies to Include in Your House Purchase Contract

What are contingencies in real estate contracts, and how do they help you when purchasing?

The standard home purchase contract lists several conditions that must be met before the closing date. These conditions are called "contingencies" because they make the closing contingent upon certain requirements being met before closing. Most of the time, contingencies relate to issues such as financing, inspections, insurance, and appraisals. As a buyer, contingencies are vital: They provide you with an escape hatch from the purchase if, for example, your financing falls through or other uncontrollable events or discoveries create barriers to your finalizing the deal.

Buying a house is not like buying a television from a department store, where you can simply return it within 30 days if you decide you don't like it. Once the ownership deed is transferred, it's a done deal. Most of the time, you know very little about the actual condition of the house when you make an offer. Also, a lot can happen—much of it out of your control—between the acceptance of your offer and the closing date. By placing at least a few contingencies on the purchase, you give yourself the opportunity to make sure that completing the deal is the right thing to do—and an option to back out before it's too late.

How Contingencies Work

Both you and the sellers can (and probably will) ask that a number of contingencies be included in the written purchase contract. (As a practical matter, most of your negotiating over contingencies will be done in writing via your written offers and counteroffers.)

Standard home purchase contracts (often prepared by state Realtor associations or the state itself), already contain many of these contingencies. Placing a contingency requires you to do little more than check a box. Even if you use paperwork prepared by a lawyer, chances are good that it will contain boilerplate contingency clauses pulled from a template.

The purchase contract will build in a certain amount of time (probably several weeks) between the contract signing and final "closing" of the deal. The closing date is the date at which the title of the property formally transfers from seller to buyer. (In some states, this period is called "escrow.")

During this time period, you and the seller will be working hard to meet or remove the various contingencies. For example, you might be scheduling inspections, and the seller might be working with the title company to secure title insurance. Each of you will advise the other party of progress being made. If either of you fails to meet or remove a contingency, you can either cancel the purchase or renegotiate around the issue.

Types of Contingencies in a Home Purchase Contract

Some contingencies are quite standard, and both you and the seller would probably be foolish not to include them. Below are some common purchase contract contingencies:

Buyer's Inspection Contingency

Essentially, this contingency conditions the closing on the buyer receiving and being happy with the result of one or more home inspections. Home inspectors are trained to search properties for potential defects (such as in structure, foundation, electrical systems, plumbing, and so on) that might not be obvious to the naked eye and that might decrease the value of the home. When this contingency is used, buyers can arrange for (at their own expense) one or more inspections of the property during what's commonly referred to as the inspection period. If an inspection reveals a problem, the parties can either negotiate a solution to the issue, or the buyers can back out of the deal.

Financing Contingency

This contingency conditions the sale on the buyers securing an acceptable mortgage or other method of paying for the property. Even when buyers obtain a prequalification or preapproval letter from a lender, there's no guarantee that the loan will go through—most lenders require significant further documentation of buyers' creditworthiness once the buyers go under contract. Having this contingency in place allows the buyers an out in the event the lender refuses to underwrite a mortgage after it delves further into the buyers' finances.

Because of the uncertainty that arises when buyers need to obtain a mortgage, sellers tend to favor buyers who make all-cash offers, leave out the financing contingency (perhaps knowing that, in a pinch, they could borrow from family until they succeed in getting a loan), or at least prove to the sellers' satisfaction that they're solid candidates to successfully receive the loan.

Insurance-Related Contingencies

Many buyers add a homeowners' insurance contingency to their contracts. That's because homeowners living in states with a history of household toxic mold, earthquakes, fires, or hurricanes have been surprised to receive a flat out "no coverage" response from insurance carriers. You can make your contract contingent on your applying for and receiving a satisfactory insurance commitment in writing.

Another common insurance-related contingency is the requirement that a title company be willing and ready to provide the buyers (and, most of the time, the lender) with a title insurance policy. Title insurance protects buyers from the possibility that the current—or previous—sellers didn't have free and clear ownership of the property. If you were to discover a title problem after the sale is complete, title insurance would help cover any losses you suffer as a result, such as attorneys' fees, loss of the property, and mortgage payments.

Appraisal Contingency

In order to obtain a loan, your lender will no doubt insist on sending out an appraiser to examine the property and assess its fair market value. If the appraised value comes in lower than what you're paying, the lender will be reluctant to fund the loan, giving that its collateral isn't worth enough to cover a foreclosure sale. By including an appraisal contingency, you can back out if the sale fair market value is determined to be lower than what you're paying. Alternatively, you might be able to use the low appraisal to re-negotiate the purchase price with the sellers, especially if the appraisal is relatively close to the original purchase price, or if the local real estate market is cooling or cold.

Other Contingencies

Beyond these common contingencies, there might be others in the standard purchase contract, and still others you or the seller might want to add.

For example, the seller might ask that the deal be made contingent on successfully buying another house (to avoid a gap in living situation after transferring ownership to you). If you need to move quickly, you can reject this contingency or demand a time limit, or offer the seller a "rent back" of the house for a limited time.

Likewise, you can request that the deal be made contingent on the sale of your current house; but in a slow market, where it might take you months to sell, the seller is liable to balk at this.

Next Steps

Once you and the seller agree on any contingencies for the sale, be sure to put them in writing in writing. Often, these are concluded within the written home purchase offer. For help, see Nolo's Essential Guide to Buying Your First Home, by Ilona Bray, Ann O'Connell, and Marcia Stewart.

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