I know this is a dry topic, but it's an important one for anyone thinking about buying or selling a home. Bear with me here!
(I am a real estate broker licensed in the state of Oregon. The following information is typical for my area but contingencies can vary from state to state and transaction to transaction. Consult a local real estate professional for information specific to your area, or contact me for a referral.)
What in the world is a contingency and why should I care about it?
A contingency is a provision in a real estate contract that specifies the contract would cease to exist upon the occurrence of a certain event.
Understanding the contingencies is extremely important for both the buyer and the seller.
For a seller, understanding the contingencies is key to reviewing offers and comparing apples to apples. Generally speaking, the less contingencies in an offer, the better the chances are for a smooth, successful transaction. For example, an offer with a financing contingency may not be as favorable as a cash offer.
For a buyer, the various contingencies that are written into the sale agreement (the real estate contract, also called an Earnest Money Agreement or EMA) protect their interests and their earnest money.
What's earnest money?
This is a deposit made to the seller, usually held by the escrow company, that shows the buyer's good faith in a transaction. It is usually delivered to the escrow company within a few days of an accepted offer.
If the buyer were to back out of the contract with no cause and outside of a contingency, then the seller would keep the earnest money. If the sale goes through, the earnest money is either refunded to the buyer or goes towards the down payment.
Earnest money varies in amount but could be fairly low, i.e. a couple thousand dollars, or very high, i.e $20,000+.
Disputes over earnest money are the most common reason that buyers and sellers end up in arbitration, mediation, or small claims court. So, it's important for both buyers and sellers to understand the real estate sale agreement and all of the applicable contingencies.
This sounds scary! If I'm a buyer, how do the contingencies protect my earnest money?
If a contingency is not removed or the buyer backs out of the sale agreement for a reason covered by a contingency, then the buyer would get their earnest money back. Contingencies exist primarily to protect the buyer's interests.
What are some contingencies commonly found in real estate sales agreements?
This isn't a comprehensive list (not even close!) but here are 5 contingencies that you'll commonly see:
- Title Insurance
- Condominium documents
- Sale of another property (Contingent Right to Purchase)
Boil it down for me. What do I need to know about these?
I gotchu. But, before we really dive into this, let me say that the below only applies to residential real estate sale agreements in the state of Oregon using up-to-date OREF forms (and assuming that your agent is using the correct ones!).
If you are entering into a sale agreement with a seller that is using their own contract (this happens frequently with new construction homes) or you choose to use some other type of contract, then I strongly suggest seeking the advice of a qualified real estate professional or proceed completely at your own risk.
Also, real estate is by nature an ever-evolving industry. The paperwork professional Realtors like myself utilize changes frequently, so be aware that some of the below information may not remain accurate.
The financing contingency is in place from the beginning of the transaction, all the way to the very end (unless it's a cash purchase). In the standard language of the current residential sale agreement, two conditions must be met:
- The buyer AND the property must qualify for a loan from the lender.
- The lender's appraisal shall not be less than the purchase price.
If either of these conditions fail, and the buyer notifies the seller within the time period stipulated in the contract, then the transaction would terminate and the buyer would receive their earnest money back.
Or, the buyer and seller can reach a mutual agreement of price and terms that allows the transaction to continue. For example, if the appraisal comes in low, the buyer and seller may renegotiate the price down to the appraised value or the buyer may bring cash to closing to cover the difference.
Once an offer is mutually accepted, the Licensed Professional Inspection contingency begins. Unless the buyer waives it.
Please, please don't waive it. There are very rare cases where waiving the inspection might make sense. That should be an extreme exception, though.
During the inspection contingency, often referred to as the inspection period, the buyer, at their own expense, can have the property and it's various elements inspected by one or more licensed professionals of their choice.
The general inspection is usually where a buyer would start. If the inspector identifies areas of concern where a specialist is recommended, then the buyer can have that specialist come in and take a look (again, at the buyer's expense).
For example, if a general inspector identifies a potential structural issue with the home, foundation, decking, or other area, then the buyer may want to have a structural engineer come out to give a professional opinion. It could be that there is no cause for concern. Or the house may be ready to slide down a hill.
The buyer has a specific amount of time in which to complete the inspections and submit a Repair Addendum that asks the seller to correct the defects. This, in a nutshell, re-opens negotiations. The seller may agree to everything on the repair addendum, reject it, or accept it with some modifications. If the repair addendum is sent back with modifications, the buyer can either accept it, terminate the transaction, or send it back again to the seller with more modifications.
And so on.
The buyer can walk away from the transaction at any time during the inspection period by providing the seller with written unconditional disapproval of any of the inspection reports. (Although, if mutual agreement is made on a repair addendum or other addendum, sometimes the buyer will waive the remainder of the inspection contingency.)
Unconditional disapproval means that the buyer can terminate for any reason during the inspection period (based on anything found in the inspection reports) and receive their earnest money back. But, the unconditional disapproval must be submitted to the seller by 5PM on the last day of the inspection period.
If 5PM of the last day of the inspection period passes with no agreement between the buyer and seller to fix anything (or other arrangement, such as a financial credit for the buyer to do the repairs themselves) then the inspection contingency is removed and the purchase will continue with the home in "as-is" condition.
Understanding this contingency and the timelines for it is vitally important to a smooth transaction.
Title Insurance Contingency
After mutual acceptance of an offer, the seller will contact the title company to order a preliminary title report and copies of all documents of record. These documents should all be provided to the buyer.
It's the responsibility of the buyer to review these documents and talk to the title insurance company for clarification of any information that is not understood.
If there is anything that is found to be unacceptable, then the buyer must notify the seller in writing, usually within 5 business days of receiving the documents. The seller then has 5 business days (usually) in which to correct the issue or come to an agreement with the buyer that the issue will be remediated prior to closing.
While title issues aren't typical, they do happen. It's important to pay attention to these documents, because fixing title issues after you become the new owner can be tricky!
(This also applies to townhomes, attached homes, single family residences, etc. that are part of an HOA or have CC&Rs.)
Another set of documents that the seller is required to provide to the buyer (assuming that the contract documents used by the buyer/seller stipulate this) are various documents related to the Home Owner's Association (if the property is part of one). In some cases, the home may not be part of an HOA, but still be a townhouse or in a planned community with CC&Rs.
Condominium documents may include: CC&Rs (conditions, covenants, and restrictions), HOA articles of incorporation and bylaws, rules and regulations, meeting minutes, latest reserve study, current HOA assessments, budgets, insurance info, etc.
The seller has the responsibility to provide these documents (usually found through contacting their HOA or management company), usually within 7 business days of mutual acceptance of an offer.
The buyer has the responsibility to review the documents (which can easily encompass hundreds of pages of information). This "Review Period" usually lasts 5 business days. It's similar to the inspection period in that the buyer has the option to unconditionally disapprove of any of the documents and receive back the earnest money as long as they notify the seller of the unconditional disapproval before the end of the Review Period.
There is usually a LOT of information in these condo documents. While it can be dry reading, there is no substitute for a buyer taking the time to read through them. The Realtor should read through them, too, but there may be restrictions or other information in the condo docs that are a deal breaker your Realtor didn't know anything about.
For example: a buyer tells their Realtor that a garage space is very important because they always keep their vehicle garaged. The Realtor finds a great condo with an oversized garage and an offer is accepted. A few days later, while reading through the condo docs, the buyer finds that doing any mechanical work to a vehicle at the complex is prohibited.
That's a deal breaker the buyer didn't even think could be an issue until they read the documents. If the buyer hadn't read the documents, they would have been extremely disappointed after the sale concluded when they realized that they couldn't do any work to their vehicle.
Some HOAs can be extraordinarily restrictive. Definitely take the time to read all the info!
Another thing to watch out for when reading through condo documents is any evidence that the reserve fund isn't healthy. If it appears underfunded or their projections for repairs/replacements seem unrealistic based on the condition of the property, then this could be a sign that a special assessment or big HOA fee increases are coming soon.
Sale of Another Property (Contingent Right to Purchase)
The Contingent Right to Purchase makes the sale of the seller's home contingent upon the sale and closing of the buyer's current property. When a buyer makes an offer (the sale agreement) they may or may not include this contingency.
The popularity of this contingency waxes and wanes based on the state of the real estate market, but regardless of how "hot" a market is, there will always be some buyers that need to sell their current home and prefer to do so while concurrently purchasing another property.
Since the seller has little to no control over the sale of the buyer's current home, this contingency would make the offer less than ideal to the seller. But, there are steps that a buyer's agent can take to help assure the seller that their buyers are serious about selling their home and are willing to do what it takes to sell it quickly.
If an offer with this contingency is accepted, then the home moves from being an "Active" listing to being "Bumpable". This means that the home is still open to offers from other buyers and usually will still show up on various online search platforms. However, if the buyer's current home receives an offer that is accepted, then the seller's home would change to "Pending".
There is a lot that can happen when an offer is contingent upon the sale of another property. For instance, the seller may find another buyer while in Bumpable status. If so, the seller must provide notice to the current buyer. The current buyer has the option to remove the contingency and proceed with the sale (so the seller would not be able to move forward with the new buyer) or they can terminate and the seller would then be free to accept an offer from another buyer.
Whether you are a seller considering an offer with this contingency, or a buyer considering placing offers with this contingency, it's important to discuss this in detail with your real estate agent.
What it all Means
These are just a few examples of contingencies and situations that commonly occur during a real estate transaction.
Buying and selling residential real estate is a complicated process, so if there is one thing to take away from this article, it's:
Don't be afraid to ask your Realtor, title agent, lender, inspectors, and everyone else on your team of professionals lots of questions! They all should be working hard for you and are there to help you navigate through the process as smoothly and painlessly as possible.