Whether you are the buyer or the seller in a residential sales transaction, you will surely come across a “contingent offer” clause in your sales contract. These clauses have important legal implications and should be thoroughly explained and understood by all parties to the contract. Specifically, a “contingent offer” means that a seller has accepted an offer from a potential buyer, but the final sale is contingent upon certain conditions being met before the sale proceeds to closing. While contingency clauses come in various forms, they are most commonly related to the home inspection, the appraisal, the buyer’s mortgage approval, and a home sale contingency clause.
Generally speaking, contingency clauses are included in sales contracts to give the buyer a way out of the contract should something go wrong with the deal, without the risk of losing any earnest money deposit previously tendered.
Below we will discuss and explain the four major types of home contingency offers.
1. Home Inspection Contingency Clause
Typically, the home inspection contingency is the most important one for home buyers. This contingency clause allows buyers to have the property inspected by a professional or certified home inspector after they tender their earnest money deposit to the seller. After the inspection, if the certified home inspector finds that the property has one or several deficiencies, the Buyer could very well walk away from the deal. On the other hand, the buyer could decide to negotiate with the seller if they still want to pursue the purchase. This often involves the buyer receiving some kind of credit, a lower asking price, or the seller agreeing to make the necessary repairs at their expense prior to closing. It is never advisable for a buyer to waive the home inspection contingency clause. As such, most real estate brokers will agree that a home inspection contingency clause is a must-have in every sales contract.
Keep in mind, if there is something wrong with the property, a qualified home inspector will find these issues potentially saving the buyers hundreds and thousands of dollars. Generally speaking, with few exceptions, you should order a home inspection for the property.
2. Appraisal Contingency Clause
An appraisal contingency is another type of contingency clause that is commonly found in a sales contract. Specifically, an appraisal is a process where a certified appraiser licensed within the state evaluates the property being sold and offers the buyer and lender an unbiased opinion regarding the property’s fair market value based on various factors. If the appraiser’s opinion indicates that the sales price is higher than the fair market value of the property, the buyer can walk away from the deal. In the event that the seller still would like to sell the property to the buyer, the seller could potentially lower the price to match the appraised value.
Overall, it would be foolish for any buyer to waive this clause. This is because a mortgage lender will only lend up to a certain percentage of the fair market value of the property. For example, a lender may only lend up to 90% of the property’s value and require the buyer to fund the remaining 10% of the purchase. As such, if a buyer chose to move forward with a purchase where the final sales price exceeds the appraised value, the buyer would have to make up the difference themselves. Also, if a buyer has waived this clause but does not want to move forward with the purchase, the buyer will probably lose their earnest money deposit.
Overall, most experts agree that waiving the appraisal contingency clause is a risky gamble for buyers.
3. Mortgage Contingency Clause
A mortgage contingency clause operates similar to the way that a home inspection and an appraisal contingency clause operates in that it allows the buyer to walk away from the deal in the event that they cannot obtain a mortgage. A well-drafted mortgage contingency clause will include a time frame by which the buyer must commit to a mortgage loan. It may also go into detail regarding the interest rate that the buyer is obligated to set or set a ceiling on a reasonable interest rate. For example, a common mortgage contingency clause may indicate that a buyer does not have to accept a loan with an interest rate higher than 8%. In that event, as long as the buyer can show a good faith effort that they tried to obtain a mortgage loan under 8 percent to no avail, they would be entitled to walk away from the deal and receive their own earnest money deposit back.
4. Home Sale Contingency Clause
The fourth contingency clause commonly found in a sales contract is called a home sale contingency clause. Specifically, a buyer would want this clause in the contract when they are buying a home contingent upon their current home selling first. This avoids buyers being in the position where they are stuck owning two properties at the same time, paying two mortgages and paying or the upkeep of two homes. Keep in mind that the average homebuyer can’t afford to maintain two home mortgages simultaneously. As such, a home sale contingency clause is required to avoid this costly scenario.
To avoid any confusion as it relates to qualifying for a mortgage, it is important that buyers get qualified as soon as possible, so they have a good idea of what terms to expect.
Similar to how some buyers treat an appraisal contingency. Waiving this contingency is also a risky gamble in the event that the lender denies your loan or you receive less than favorable terms and/or interest rates. Overall, you will run the risk of losing your earnest money deposit or being tied to a mortgage with unfavorable terms.
In strong sellers’ markets, anxious buyers may be pressured or feel pressured to waive contingency clauses in fear that they may lose out on the property. However, under most circumstances, it’s a risky gamble for buyers to waive any contingency clause.
Buyers can lose their earnest money deposit, make a bad purchase, or end up overpaying for the property, all of which are not ideal for buyers.