In an intense seller’s market, buyers may consider waiving contingencies to give them an edge on the competition. What is a contingency, exactly? Simply put, a contingency is a stipulation put into the purchase offer that protects the buyer in case something goes wrong. Basically, the buyer can back out of the contract without losing their earnest money deposit or facing penalties.
If a buyer decides to waive a contingency in order to entice the sellers to accept their offer, the buyers may not be able to back out of the contract without penalty if something goes wrong. What are the most common contingencies, and what should you know if you choose to waive them?
Home Inspection Contingencies
One of the most common contingencies in real estate is known as an inspection contingency. A home inspection contingency essentially states that the purchase of a home is dependent on the results from the home inspection. The right to an inspection exists to protect buyers from purchasing a home with substantial (and potentially expensive) faults. However, the right to inspect must be specified in the purchase contract in order for a buyer to have the opportunity to inspect. This critical contingency often provides buyers with the opportunity to terminate a purchase if they are not satisfied with the inspection and condition of the property.
In an intense seller’s market, bidding wars are common. Some buyers may choose to forego a home inspection as a way to stand out from the crowd and maximize the chance their offer is accepted. The risk in this strategy is that a buyer could purchase a home with several substantial problems and looming repairs. While it may help the buyer win a bidding war, foregoing the inspection contingency could offer more risk than reward. By keeping an inspection contingency in the offer, buyers are alerted of potential issues with the home and they may be able to back out of the contract because of those issues.
Appraisal Contingencies
One of the contingencies most often waived by home buyers is the appraisal contingency. This contingency states that if the home doesn’t appraise for the amount the buyer agreed to, the buyer can back out of the contract. Appraisals exist to ensure buyers don’t overpay for a home and also offer an “out” for buyers if the home is appraised for less than the purchase price.
If there is an appraisal gap – the difference between what the home appraises for and the amount you offered for the home – you may end up having to pay the difference if you don’t have an appraisal contingency in your contract.
Sale and Settlement Contingencies
When a home buyer is also a homeowner in the process of trying to sell their home, they may make an offer on a house with a sale and settlement contingency. This simply means the purchase of the new house won’t take place until the buyer’s home sells. There is usually a specific date in the contingency and if the buyer’s house doesn’t sell by that date, the contract is terminated. Sellers are often wary of offers with this contingency attached because there’s no guarantee that the buyers will sell their house by the specified date.
However, if the buyer has an offer on their home and they are just waiting for the closing to take place, they may make an offer on a house with a settlement contingency. This means they already have the sale, but just in case the house doesn’t close as expected, the contract will be terminated. Typically, these home sale continencies don’t allow the seller to accept other offers for a specific period. And even if the contract allows the sellers to continue to accept offers, the house will be most likely be listed as “under contract,” so other buyers are less likely to consider the property.
Other Reasons a Buyer Might Back Out
While inspection & appraisals are the common reasons for backing out of a contract, there are other scenarios that arise that cause a buyer to terminate:
- Time Is of the Essence– In every contract, there are typically deadlines for both the buyer & seller to meet. If a buyer has fulfilled their obligations but the seller has not and the transaction does not close on time, a buyer could potentially back out of the purchase.
- Death of the Buyer– In many states, if the buyer dies prior to closing, the purchase is terminated. It’s important to consult an attorney if the estate has any obligation to complete the purchase.
- Loss of Job– Most contracts that involve the buyer obtaining a loan include a financing contingency. If a buyer is unable to obtain loan approval, then this contingency typically gives them the right to terminate since they are not able to financially purchase the home. Beyond credit issues, a common reason for loan denial is when the buyer loses a job during the course of the transaction prior to closing.
- Specific Contingencies– For example, if a buyer makes an offer sight unseen, they can include a contingency that the offer is subject to their viewing & approval of the property. If they aren’t satisfied, they may be able to back out. Other specific contingencies can exist on a case-by-case basis, so consult with your real estate agent.
What to Know Before Backing Out of a Contract
Keep in mind, once an offer is made and accepted, it’s a legally binding contract. It’s critical to read the entire contract and all the fine print before signing. While there are a few scenarios where a buyer can legally back out of contract, there is also an important legal term buyers and sellers should be aware of: specific performance. Unique to real estate, specific performance means there is no form of adequate compensation for when a buyer or seller backs out of a sales agreement, therefore both parties must uphold the agreement if it is deemed fair and equitable by the court.
A simple change of heart about purchasing (or selling) a home may not be legally protected and could result in a specific performance lawsuit. If a buyer wishes to terminate a contract, it’s critical to consult a licensed attorney about the legal ramifications of that decision before terminating. It’s important to note that even if you’re working with a buyer’s agent, they are not allowed to give legal advice.
