Price is not the only factor you want to consider when writing an offer. What contingencies you keep or waive is just as important, and can help make or break your offer, especially in a competitive situation when you are up against other offers.
What are contingencies?
Contingencies are a critical part of an offer to purchase a home, and should be carefully considered. The three most crucial contingencies are
- loan contingency
- inspection/disclosure contingency
- appraisal contingency
As a buyer, you can decide what contingencies to include in your offer, and for what period of time. And depending on the nature of the current market and how competitive you want to be as a buyer, you can decide if you want to waive any contingencies.
Contingencies are clauses in a Residential Purchase Agreement that are meant to protect buyers. They give you time to complete your due diligence as a buyer, such as obtaining a loan, completing an appraisal, and completing any inspections you see fit. If any issues arise during the process or the findings are not to your liking, you have the right as a buyer to either re-negotiate or cancel the contract under the provision that that particular contingency provides, within the time frame specified in the offer. So, it is important to understand what each contingency entails.
What are the 3 most important contingencies to be considered when writing an offer?
Loan Contingency – Hopefully as one of your first steps to your home buying journey, you met with a loan officer to obtain your pre-approval letter.
→ Having this letter in hand conveys to home sellers and listing agents that you are a qualified buyer, and enables you to start offering on homes.
However, in most cases a pre-approval letter is just that, “PRE”-approval. Unless your mortgage professional has already put your file through underwriting to obtain full approval, it is (in most cases) in your best interest to keep your loan contingency in place.
Once you have an offer accepted by a seller and you are in escrow, the loan officer will start to move forward with processing your loan. This includes verifying all income and assets, ordering an appraisal to be performed on the home, providing you with a complete breakdown of what your monthly payments will be, etc. Your file is then sent to the underwriting team, who verifies all the information is complete and accurate. Sometimes, they may request additional documents or information.
Once this process is completed, your loan is then formally approved, and you can “lift” or “remove” your loan contingency. Most times it is best to protect yourself as a buyer with a loan contingency in case any hiccups happen along the way, and in the most unfortunate circumstance (you lose your job, for example), your loan is not approved, and you need to cancel the contract.
Appraisal Contingency– When you get an offer accepted, your lender will order up an appraisal to be performed on the home.
→ The appraiser is a neutral, licensed professional who will perform an appraisal on the house and provide a written report. They will visit the home to investigate the physical condition, and will check comparable sold properties in the neighborhood. With all of this information combined, they will give the house an “appraised value.”
The important thing to keep in mind is that your lender will only provide a loan up to the appraised value. If you have included an appraisal contingency with your offer, you have room for negotiation should the appraised value come in less than what your offer price is.
For example: if your offer price is $500,000, and the appraised value comes in at $495,000, there is a $5,000 difference. If your appraisal contingency is in place, you are able to negotiate with the seller to try to close the gap in the difference, so that you as the buyer don’t have to bring in the difference in cash at the closing table.
However, keep in mind that the seller is not obligated to agree to a change in the purchase price should there be any difference in appraisal. The point is that keeping the contingency in place gives you options as a buyer. The seller may agree to match the purchase price with the appraisal, they might meet you halfway, or you may decide to bring in the difference in cash to close the difference, or, if compromises are not made, you can decide to cancel the contract within your appraisal contingency period.
On the flipside, if the appraised value comes in higher than the contract price, the buyer is under no obligation to pay a higher price for the home.
Inspection & Disclosure Contingency – This is probably the most misunderstood contingency. Many people think that this simply means physical inspections. Below is a list of many considerations that fall under the umbrella of inspections and disclosures. If during your inspection contingency time frame, you discover matters about the home that are not to your liking, you can renegotiate or cancel the contract within the allotted time for the inspection contingency. Here are some factors to consider:
- Physical inspections: As a buyer you have the right to hire a professional inspector to do physical inspections such as a property/home inspection, termite inspection, roof inspection, pool inspection, chimney inspection, etc. depending on the particular home. (Please watch my “Inspections” video for more details)
- Disclosures: There are quite a few disclosures that are required for any California real estate transaction that both seller and buyer need to review and sign. While many of these disclosures are purely informational, such as the Lead Based Paint Disclosure and Water Heater Statement of Compliance, there are a few disclosures that sellers are required to fill out, disclosing important information about the subject home, such as any updates to the home, easements on the property, rodent or pest issues, noise from neighborhood nuisances or airplanes, any deaths on the property within the last 3 years, and other pertinent information that buyers should be aware of before deciding if they want to purchase that home.
- HOA Documents: This contingency also covers HOA documents, if applicable to your home.
- Square footage verification: if your property of interest has had any additions, it is recommended to check with the city to make sure that the additions have been done with any necessary permits. Only additions done with permits can be counted into the overall square footage of the house, adding to the value, especially if/when you decide to sell.
- NHD: Natural Hazard Disclosure report. This report discloses whether the subject property falls within an earthquake fault zone, flood zone, dam inundation area, right to farm area, etc.
- Investment property considerations: if you are buying as an investment property, there are a few additional precautions you want to take. For example, if the home is a townhouse or condo, the HOA will sometimes restrict what percentage of the units in that complex can be rented out. You want to make sure that there is room in the percentage for you to use that property as a rental.
- Neighborhood: do you get good cell service in the house? Is there any noise from airports, trains or schools? Is there a high crime rate in the area? All of these considerations fall within the Buyer Inspection contingency. Buyers have the right to thoroughly investigate all matters affecting the property.
- Insurability of a home: are you in a flood or fire hazard area?
- All other matters on the Buyer’s Inspection Advisory (attached for reference)
What happens if I try to cancel the contract after contingencies are lifted?
Contingencies are meant to protect you as a buyer, and give you the time necessary to allow you to do your due diligence and investigate all matters of the home so you feel comfortable with moving forward with the purchase. However, once you waive your contingencies, you are giving up your right to cancel that contract and get your deposit back. A deposit (usually 3% of the purchase price), is held in escrow as your “Earnest Money Deposit,” which lets the seller know you are entering into the contact in good faith and that you intend to purchase the property, should everything go smoothly during your due diligence period. If you decide that you want to cancel the contract and you no longer want to purchase the home after you have waived your contingencies, the seller has a right to your deposit to recoup the time lost while in escrow with you. On the other hand, if you want to cancel the contract based on a concerning finding in the home inspection report, or if there is a huge gap in appraisal value vs. your offer price, for examples, you can cancel the contract and receive your deposit back rightly-so, as long as you cancel within the particular contingency period that you allotted for yourself in your offer.
What are the benefits of waiving contingencies?
In a very competitive market, many buyers decide to waive contingencies upfront in hopes of creating a more appealing offer for the seller. The reason waiving contingencies makes your offer “stronger” in the eyes of a seller, is because you are conveying to the seller that you are very serious about the property and you don’t intend to back out of the contract. Of course, waiving contingencies upfront should not be taken lightly, and as a buyer you should discuss this with your Realtor® and your loan officer to decide if you are safe to do so. For example, if a seller has already performed all of the important physical inspections recently and you have reviewed the reports and are ok with the condition of the home, you may consider waiving the physical inspection contingency portion. Or, if you have thoroughly reviewed the comparables in the neighborhood with your Realtor® and you are confident that the price you are offering is in-line with the other recent sale prices of similar homes, you may feel comfortable waiving your appraisal contingency because you don’t anticipate a huge gap in the appraisal value vs. your offer price. Again, each contingency can be carefully considered, and your agent can advise which contingencies are safe to waive, if any.
Any more contingency questions?
When preparing an offer to purchase a home, it is best to consult with your Realtor® to decide what contingencies to keep in place, and for how long, or to discuss the option of waiving any contingencies up front. My job as a professional Realtor® is to educate you and give you all the information to help you make not only an informed decision, but a decision you are comfortable and happy with. Please do not hesitate to contact me with any questions!
REALTOR ®, BRE #01950753