If you’re a buyer or a seller, you’ll need to understand the three most common real estate contingencies found in most purchase and sale agreements: financing, appraisal and inspection. These contingencies affect almost every real estate transaction and must be satisfied in order for the deal to close.
Before we get started, we should answer the question, “What are real estate contingencies?”. Contingencies are conditions of a real estate transaction. Each contingency will have a deadline in the contract or purchase agreement. If you fail to meet the conditions, you risk the possibility of the deal not closing. That is why it’s so important to inform yourself and know everything about contingencies and the roles they play in a real estate purchase.
Let’s break down each of the three standard contract contingencies below…
1. Finance Contingency:
Unless you are coming to the table with a cash offer, you will need to secure financing to buy a home. The main purpose of the finance contingency is to protect the buyer from any unforeseen hiccups/changes that may come up during the underwriting process once under contract. Most contracts will state that the buyer has a specific amount of time to secure a loan. It may even list out more details about the financing, such as what type of loan it is, the amount of the down payment, the loan term and what interest rate has been secured. As a buyer, you will most likely want to include this contingency in your purchase agreement if you plan on paying for the home with a loan.
You were probably pre-qualified when you began your home search. Pre-qualification is not enough to release the finance contingency. Instead, you should be pre-approved. Pre-approval requires the buyer to complete a loan application so the lender can review the buyer’s credit history and finances. These steps allow the lender to commit to issuing the loan assuming nothing major changes with the buyer’s financial picture. To put it simply, if a buyer is unable to secure a loan commitment from a lender, the deal cannot close and the contract will be terminated at no fault to the buyer with this contingency in place.
In a hot market (much like Nashville’s), some buyers may opt out of the financing contingency. This is a substantial risk, but it does make an offer look more appealing to a seller entertaining multiple offers. In this instance, the buyer would typically be, at the very, very least, forfeiting their earnest money deposit should they default on the contract due to their inability to get a loan. Again, this is a very small minority. The financing contingency is arguably the most common contingency and you should not be concerned about including it.
2. Appraisal Contingency
The appraisal contingency is important because it protects the buyer from potentially overpaying for the house. The buyer relies on the appraisal to make sure the property is worth the price agreed upon in the contract.
What is an appraisal you might ask? An appraisal is the process of determining the value of a property during escrow to make sure the agreed-upon purchase price is not higher than the actual value of the property determined by a trained appraiser. If the property doesn’t appraise for the contract price or above, the buyer has the right to cancel the contract if they wish. However, most buyers opt to use this opportunity as a chance to renegotiate the price in an attempt to continue on the path towards closing. If the seller refuses to negotiate, the buyer can then back out of the deal.
If you are looking for a way to strengthen your offer in a seller’s market, this is one contingency that the buyer may opt to waive. When an appraisal is waived, this guarantees the seller the price negotiated in the contract. If the buyer is getting a loan, the lender is still going to require an appraisal (they’ll only loan based off of the appraised value). However, you can still waive this contingency if you wish. You’ll simply be responsible for bringing the difference between the appraised value and contract price to the closing table in cash.
3. Inspection Contingency
Also known as a “Due Diligence Period,” the purpose of the home inspection is to allow buyers to inspect the property during escrow in order to feel satisfied with the condition of the home prior to closing. As REALTORS®, we strongly recommend that every buyer hire a professional home inspector to inspect the property and report on its condition. Feel free to ask us for recommendations! If you choose to select your own inspector, it’s important to make sure he or she is certified by ASHI (American Society of Home Inspectors).
What’s included in a standard home inspection? Anything that is visible. Inspectors will not open walls or ceilings or dig below the ground. They will, however, check the general integrity of the structure and check the exterior, roof, electrical system, heating/cooling system, interior plumbing (this does not extend to the piping outside of the home), appliances, attic, basement, garage, grounds and any potential safety issues. Most standard inspections do not include mold, radon, methamphetamine, lead paint, asbestos, pests and sewer lines. These are typically an additional cost and we think they are well worth it!
It is highly recommended that buyers attend the inspection in order to learn more about the property and to ask questions. Warning: your inspection may include many issues. You should consult your real estate agent to see which ones you can live with and which ones are worth addressing. Some issues may require a specialized professional. We’ve seen hundreds of inspection reports, so our team will be happy to help you decide how to move forward. Most problems can be fixed, but some issues (such as black mold and sinkholes) are deal breakers in our opinion!
Once the inspection report has been reviewed by the buyer, their real estate agent can draft an official inspection request list. This document will list any items that the buyer wants to be fixed before the deal closes. Some buyers may request a reduction to the agreed-upon purchase price so they can correct the issues themselves and have control over the level of workmanship. Depending on whether the market is in favor of buyers or sellers, the sellers may or may not agree to correct the issues. Generally, most sellers will offer to help fix some of the issues. In multiple offer situations, some sellers may say “take it or leave it.” If both parties cannot come to a compromise, the contingency allows the buyer to walk away. The inspection contingency also protects sellers from lost time. If the inspection requests are not submitted by the deadline stated in the contract, it could mean that the buyer must accept the property in “AS IS” condition and the seller does not have to make any repairs.
The inspection is another contingency buyers opt to waive in order to strengthen their offer. Talk to your real estate agent, but there is also an option to waive your right to ask for repairs but you still have the right to get an inspection and make your decision between accepting it in “AS IS” condition or walking away.
As a buyer or seller, you’re most likely going to be dealing with contingencies as part of the real estate transaction. The three contingencies mentioned above are very common and should not raise any red flags to a seller. As a buyer, contingencies are especially important as they can prevent you from getting “trapped” into buying a home that you cannot afford or that you no longer want based on information you may not have seen at the time of your initial viewing.
We hope that we have provided some valuable information! If you are considering buying or selling, please contact The Southbound Group, your Nashville Real Estate Experts! Visit our website for more information.