06.18.15 by Jeff Johnson
What if you’re under contract to buy a home and then find out it has big problems? Home buying contingencies give you a way out.
Most home buyers are comfortable with searching for properties but are uncertain of the commitments they make when writing a purchase offer. One important aspect of a real estate contract is contingencies. These provisions, for an unforeseen event or circumstance, are important in case something goes wrong.
With the acceptance of an offer to purchase, buyers will make a good faith deposit, typically $1,000, to demonstrate their commitment to purchasing the property. That’s a lot of money to hand over before learning details about the property and finalizing financing. Contingencies can help protect buyers if a problem arises. They are exits on the road to closing a real estate purchase. In the California purchase contract, these contingencies must be actively removed by a buyer for there to be an obligation to purchase. The three major contingencies to know are disclosures, inspections, and loan/appraisal.
Disclosures are meant to provide the buyer with as much information as possible in order to make an informed decision, as well as to protect their soon-to-be interest in a property. Sellers deliver required disclosures to buyers after their offer is accepted, typically within 7 days in the California contract, and buyers have 17 days to review them.
Buyers will review local, state, or federal disclosures about anything from earthquake hazard zones to flood zones to disclosures about proximity to airports. In California, sellers are required to disclose, via boilerplate 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.
Keep in mind that a seller may not know everything about the home. Conditions may have existed before they lived there or are out of their expertise. Sellers are only required to disclose known defects, so you should consider hiring professionals for expert opinions on such things as pest infestation/damage.
The biggest and best of the contingencies, inspections are the “get out of jail free card” for buyers. They allow you to walk away once you’ve done agreed-upon inspections, 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. In the California contract, there is usually a 17-day period allowed for inspections.
If you do find something unexpected or undesirable, 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 to the buyer at closing. In a competitive situation with multiple possible buyers, the seller may leave the defects for the buyer to deal with as the new owner.
Ultimately, this contingency offers you the opportunity negotiate a fair price for the home, factoring in defects.
Loan approval and home appraisal
Getting pre-approved for a loan prior to making a purchase offer is only the first step in the lending process. Pre-approval is preliminary and does not mean the lender guarantees you the loan. A loan must still go through a detailed process called underwriting whereby the risk of offering a mortgage loan to a particular borrower under certain parameters is analyzed. Additionally, the loan contingency offers protection to you in case your financial situation changes; for example, if a buyer loses their job and can no longer qualify for a loan, they lost their ability to pay. If you cannot secure a loan, you have the right to cancel the contract.
Before providing funds, the lender wants to be sure that the property is worth what you offered the seller, by way of an appraisal. The appraiser is an independent third party who will walk through the home, take pictures and measurements, and evaluate its condition, then follow up with a written report. If the appraised value comes in below your offer price, you have a right to cancel or may try negotiating a new purchase price.
A property title (ownership) report will also come into play to determine if there are outstanding liens or clouds on title (issues which can affect your ownership).
In the California contract, the appraisal contingency period is typically 17 days, and the loan contingency is 21 days. These periods are often extended, because a loan approval can take 30-60 days.
Your Money is Protected
So long as you perform your contractual duties, you have a right to cancel and receive a refund of your deposit. The escrow company holding your money for the purchase is further protection, as they are a neutral, third party and keep your money away from the seller until the sale closes.
Don’t sign a purchase off without reviewing your contingency options with your agent. Understand that contingencies are terms and can sometimes be used for negotiation. If you can’t offer the highest price, the seller may appreciate moving fast once you sign a contract with short contingency periods.
— Inspiration: Zillow Blog