What Are Contract Contingencies
In this article, I want to talk a about Real Estate Contract Contingencies, what they are and how they’re used.
In Part 2 of this article, I discuss the 4 Rules of Using Contingencies to help you succeed as an investor.
For those that aren’t familiar, a contingency is a statement (a “stipulation”) that is added to your contract that will allow you the right to back out of the deal without penalty under specific circumstances. Contingencies are often used by buyers who aren’t 100% convinced they’re ready — or able — to buy the property, and want some extra time to “get their ducks in a row.”
Before I get into details of my offers, I wanted to review the most common contingencies you’ll find in a real estate purchase offer:
- Financing Contingency:
This is one of the most common types of contingency. Basically, it says that your offer is contingent on you being able to procure financing for the property. It will often be specific about the type of financing (FHA, Conventional Loan, etc), the terms (interest rate, down payment, etc), and the time period.
For example, a typical financing contingency might read as follows:
Buyer shall have 20 days from the date of binding agreement (“Financing Contingency Period”) to determine if buyer has the ability to obtain a loan with the following terms:
* Loan Amount: 96.5% of the total purchase price of the property
* Term: 30 years
* Interest Rate: No Higher Than 5.25%
* Loan Type: FHA
This agreement shall terminate without penalty to Buyer if Buyer is unable to obtain the loan described above and notifies seller in writing of this event within the Financing Contingency Period.
Any Buyer who is planning to use financing to purchase a property should include a Financing Contingency; worst case, your financing will fall through, but you’ll still have the option to back our of the deal without penalty.
- Appraisal Contingency:
This contingency basically says either:
* If you can’t get an appraisal on the property that is at least as high as the purchase price, you can back out of the deal; or
* If you can’t get an appraisal on the property that is at least as high as the purchase price, you can ask the Seller to drop the price, and if he refuses, you can then back out of the deal.
The appraisal contingency often goes hand-in-hand with the financing contingency, as the lender will not fund the loan above the appraised price.
- Inspection Contingency:
Also known as a “Due Diligence Period” or a “Due Diligence Contingency,” this contingency says that the Buyer has a set amount of time (often ranging from 5-10 days), where he can do whatever he needs to do to ensure that he wants to buy the property. This might include inspections, appraisals, contractor walk-throughs, etc.
If at any time within that inspection period the Buyer chooses to back out of the deal for any reason, he can. This is a common contingency for anyone who is not intimately familiar with inspecting properties and coming up with rehab cost estimates. The Buyer can use this time period to get a full property inspection and get bid from contractors to do any necessary work. If any surprises turn up, he can then either ask for a discount (or repairs) or just back out of the deal.
- Selling A Current Property:
This one has become more prominent these days among homeowners looking to upgrade their current house. This contingency basically says that the Buyer has a right to back out of the deal if he can’t sell his current residence to someone else. Generally, the contingency will call out a time period for which the contract is in effect, thereby giving the Buyer that amount of time to sell his other property.
This contingency is not generally used by investors, but is very common among homeowners going from one house to another.
While there are literally thousands of other possible contingencies that you might see or use in a real estate contract, these are the most common, and many of the others are based on one of these.
Some others that you might come across at some point include:
- Termite Letter Contingency
- Lead Paint Test Contingency
- Deed Contingency (stipulates what type of deed is expected from the seller at closing)
- Radon Testing Contingency
- Mold Inspection Contingency
- Sewer Inspection Contingency
- Private Well Inspection Contingency
- Home Owner Association Documents Contingency
- Insurance Contingency (stipulates that you can get insurance at a reasonable price)