What are contingencies?

What if you're under contract to buy a home, and then find out it's got big problems? Contingencies can get you off the hook.

Most home buyers organically begin and are comfortable with the real estate search process, but don’t know how to move forward once they’ve found a home they love. In order to put the search and discovery process into context, I sit down with every first-time buyer before we start searching together to go over the process, contract to close. If your agent hasn’t done this, ask them to.

One important aspect of a real estate contract is contingencies. These provisions for an unforeseen event or circumstance are important in case something goes south. At contract signing, buyers will put money in escrow typically 3 percent of the purchase price. That’s a lot of money to hand over to the seller before arranging financing and doing more due diligence than opening closet doors at the open house. Contingencies can help protect buyers if a problem arises.

Contingencies are always tied to a timeframe. The buyer must sign off physically in writing to remove the contingencies. Make sure you mark your timeframes early.

Here are the three big contingencies to know.

Inspections

The biggest and best of the contingencies, the inspection is the “get out of jail free card” for buyers. It allows you to walk away once you’ve had an inspection if you discover issues with the home. For example, it is common for buyers to uncover broken or defective items, older systems or health and safety issues.

Some argue that it would be difficult to exit a contract from a brand new and flawless home, but the inspection contingency language in most contracts provides for an easy out.

If you do find something unexpected, you don’t necessarily have to abandon the contract. Go back to the seller and see what they will fix.

Unexpected inspection issues often result in a second round of negotiations. If the items are big enough to kill the deal, the seller may agree to fix them or issue a credit at closing. In competitive markets, the seller may leave the defects for you to deal with as the new owner.

Loan approval and home appraisal

Getting pre-approved prior to making an offer is a must. Once the offer is accepted, the bank will send an appraiser to determine the market value of the house. Before it wires the funds for your mortgage, the bank wants to be sure that the property is worth what you offered the seller, by way of an appraisal (sometimes a standalone contingency).

The appraiser is an independent third party who will walk through the home, take pictures and measurements, and comment on its condition, then follow up with a written report.

Second, a title report will be issued so the lender can see if there are outstanding liens or clouds on title. For condominiums or planned unit developments, the bank wants to review the governing documents and financials to make sure all is in order.

The loan approval, which can take up to 45 days, is the longest contingency. In competitive markets, it can be done in less than two weeks. Be in touch with your lender before you make an offer, and strategize on timeframes.

Disclosures

Disclosures are meant to provide the buyer with as much information as possible to make an informed decision, as well protect their soon-to-be interest.

Sellers in most markets must disclose, via boilerplate local or state forms, their knowledge about the property and their experience living there. For example, if there was a leaky roof or if they know about a neighboring development that could affect the home’s value, they must disclose it.

Typically, sellers deliver the disclosures to buyers after their offer is accepted. Additionally, buyers will review local building department documents alongside local, state or federal disclosures about anything from earthquake hazard zones to flood zones to disclosures about proximity to airports.

Don’t sign a contract without reviewing your contingency options with your agent. Understand that contingencies are terms, and can sometimes be used for negotiation.