Contracts and Contingencies

Three contingencies protect the buyer when purchasing a home.

Purchasing a home is a journey that many people will experience at some point during their life. And if you have experienced the journey more than once, then you understand that no two transactions are the same. Searching and touring homes is one thing, being under contract to purchase a home is a completely different story. Understanding the contract side of the home buying process will protect you and give you a chance to have a pleasant journey.

I will cover three common contingencies that protect a buyer when purchasing a home. These contingencies can be waived, and they often are in a seller’s market. Before doing so, you must understand the impact of waiving a contingency.  

Before we go any further, it must be said that I am not an attorney. You should seek competent legal counsel if you need legal advice on a contract. I am discussing the real estate contract as a real estate agent who works in Virginia. Therefore, what I mention here may not apply to the market you are in.

The Journey Begins

You finally found the home of your dreams and it looks better in person than it did online. As you tour the home you envision the dinners you will cook in the kitchen, the laughs that will fill the walls on birthdays and holidays, and the memories you will create throughout your home and the surrounding neighborhood. Before you leave the home tour, you have mentally painted the walls and envisioned how your furniture will fit. By this point, you are emotionally invested in the home of your dreams.

You’re filled with excitement as you tell your real estate agent that you’ve seen enough homes and you’re ready to place an offer on the home of your dreams. Your real estate agent tells you there are multiple offers and they are all competitive. To compete, you’ll have to present an offer that is above the asking price and waive contingencies.

You’re nervous, your heart is pounding and your palms are sweaty. Your mouth is dry and you can barely think. The idea of waiving contingencies is new to you and you have no idea know what any of it means. But you know you want this home. So, you agree to waive contingencies. And before you know it you’re signing an offer that will be presented to the seller.

You’re filled with joy and excitement when you learn that your offer is accepted, but you still don’t know what you waived to make it happen.

Joy and excitement turn to worry and concern. As the journey begins you have questions about what happens next. Let’s take a look.

Contingencies

There are three contingencies I will cover. They are the most common contingencies in Virginia and the ones that are most likely to be waived by a buyer. The three contingencies are:

1. Home Inspection

2. Finance

3. Appraisal

First, let’s talk about what a contingency is. A contingency simply states the conditions that must be met before the buyer purchases a home. The buyer will purchase a home contingent upon the home inspection, finance, and appraisal contingencies all being satisfactory. If any contingency is not satisfied, then the buyer has the right to void the contract without any harm.

Therefore, waiving a contingency puts the buyer in breach of the contract if they decide to walk away from purchasing a home due to an inspection, finance, or appraisal issue.

Home Inspection Contingency

A home inspection is the first thing that happens after a buyer’s offer to purchase a home is accepted, also called a ratified contract. An offer contingent on a home inspection allows the buyer to negotiate repairs or void the contract based on the home inspector’s findings. The home inspector is a licensed professional hired by the buyer to protect their investment and make sure the home they are purchasing is free of major issues. A good home inspector will inspect the roof, foundation, windows, electrical, HVAC, appliances, and plumbing of a home. Depending on the size of the home, the home inspection can take anywhere from two to five hours.

“A home inspection contingency allows buyers to hire a professional who will tell them about major and minor issues with a home before purchasing it.”

Upon completion, the home inspector will provide a written report to the buyer detailing the good, bad, and ugly of the home. The written report will be used by the buyer to negotiate any repairs with the seller. The buyer can also choose to void the contract depending on the findings of the home inspection.

Another option is to conduct a home inspection with the option to void only. In this case, a buyer will hire a home inspector to inspect the home from top to bottom. Upon receiving the home inspection report, the buyer can choose to void the contract if the home inspector finds a major issue that needs to be addressed. The difference between this option and the one above is that the buyer cannot negotiate repairs with the seller, they either take the home as it is or void the contract.

A third option is to waive the home inspection. In a competitive market, many buyers choose this option to make their offers competitive. Waiving the home inspection means the buyer will not inspect the home before moving in. In other words, the buyer is purchasing a home without knowing the condition of the home they are purchasing. If you move into a home and find major repairs are needed then you will have to make those repairs yourself.

Discuss the implications of waiving a home inspection with your real estate agent before deciding to do so.

Real-Life Example: The Leaky Roof

I represented buyers who were under contract to purchase the home of their dreams. The offer included a home inspection contingency that protected them from major repairs. As first-time home buyers, having the peace of mind of a home inspection contingency was important to them.

During the home inspection, it was found that the roof was showing signs of leaks from recent rainfall. The cost of a new roof in this case would be $10,000, money my first-time homebuyers did not budget for. Because we had the home inspection contingency in place, I was able to negotiate a $10,000 credit from the seller to the buyer which would cover the cost of a new roof. In this situation, if we were unable to reach an agreement on the roof repair, my client would have the right to void the contract.

Without the home inspection contingency, my clients would not have known about the leaking roof until after they moved in. And by then, it would be their responsibility to repair.

Finance Contingency

Assuming you will need a mortgage to purchase your home, your offer should be contingent on receiving financing. A finance contingency protects the buyer in the event they are unable to secure financing for their home. In some cases, a well-qualified buyer may have an unexpected event happen during the home buying process, such as a loss of a job or debt which was unaccounted for during the pre-approval process. These items will be discovered during the underwriting process, which usually occurs after a contract is ratified.

The underwriting process is when a lender will verify your income, debt, assets, and details of the property you are purchasing before issuing final loan approval.

If the buyer is unable to obtain financing for the purchase of a home, then the buyer can void the contract without any legal ramifications. In this case, the lender would provide the buyer with a letter stating financing could not be obtained, and the buyer’s agent would use that letter to void the contract.

“This provides important protection for the buyer, who can back out from the contract and reclaim their earnest money in the event they are unable to secure financing from a bank, mortgage broker, or another type of lender.”

Waiving the finance contingency means the buyer cannot contractually void the contract if they are unable to obtain financing for their purchase. Without financing, the buyer is unable to purchase the home and would be in breach of the contract. Because the buyer is voiding the contract for reasons not stated within the contract, the buyer would lose their Earnest Money Deposit (EMD), which we will discuss later.

Real-Life Example: The Home Owners Association Lawsuit

I represented a buyer who was under contract to purchase a condominium that was part of a Home Owners Association (HOA). My buyer had all contingencies in place, including the finance contingency.

During the underwriting process, it was found that the HOA had a lawsuit pending. A lawsuit pending against the HOA raised red flags with the lender. Because of the lawsuit, the lender would not approve the loan for my buyer to purchase this home.

My client’s ability to purchase the home was impacted by reasons beyond their control. Because we had the finance contingency in place, we were able to void the contract without my client losing their Earnest Money Deposit.

In this case, if my buyer had waived the finance contingency, then they would be in breach of the contract even though being unable to obtain financing was no fault of their own. Because they could not obtain financing, and would not be able to purchase the home, they would have had to forfeit their Earnest Money Deposit to void the contract.

Appraisal Contingency

The appraisal contingency is one of the most misunderstood contingencies in real estate. If you’re obtaining a mortgage for the purchase of your home, then the purchase price must be supported by an appraisal. The appraiser is hired by the mortgage company and works on their behalf to ensure the home is valued at or above the purchase price. The lender will verify the appraised value of the home during the underwriting process.

For example, if you are under contract to purchase a home for $550,000, and the appraiser’s report shows the home is valued at $525,000, then the mortgage company will use $525,000 when determining the Loan to Value ratio. The remaining $25,000 must either be paid by the buyer at closing, or an agreement must be reached between the buyer and seller to reduce the purchase price.

“An appraisal contingency protects the buyer and helps ensure a property is valued at a specified minimum amount.”

An appraisal contingency will protect the buyer in the case that the two parties cannot reach an agreement and the buyer is unable to pay the difference. The buyer will have the option to void the contract without any legal ramifications.

As with other scenarios, the appraisal contingency is often waived in a competitive environment to make an offer competitive. This is especially true when the offer is above the asking price. The appraisal contingency is misunderstood because waiving the appraisal contingency does not mean an appraisal will not be done. Waiving the appraisal contingency means the appraisal will still be completed by the lender. However, the buyer must come up with any difference between the purchase price and the appraised value if one exists. In the example above, the buyer would have to come up with the difference of $25,000 or face losing their Earnest Money Deposit (EMD).

As with any contingency, discuss the implications of waiving the appraisal contingency before doing so. In some cases, waiving the appraisal contingency could cost you tens of thousands of dollars.

Real-Life Example: The Prideful Seller

I represented a buyer who was under contract to purchase a home. We were about a week away from closing and everything was moving smoothly. Then, the appraisal report came back $20,000 below our purchase price.

My client, the buyer, in a sign of good faith offered to meet the seller in the middle. My buyer would come up with $10,000 if the seller would lower the price by $10,000. The seller allowed their pride to get the best of them and refused to lower the price.

My buyer refused to cover the entire amount of $20,000 between the appraised value and purchase price. Because we had the appraisal contingency in place, we were able to void the contract based on the low appraisal and my client’s Earnest Money Deposit was returned to them.

Without the appraisal contingency in place, my client would either have to come up with $20,000 to cover the difference between the appraised value and purchase price, or be in breach of the contract and lose their Earnest Money Deposit. In this case, my client was grateful we had the appraisal contingency in our favor and they happily walked away from the contract with their Earnest Money Deposit.

Earnest Money Deposit

I’ve mentioned losing your Earnest Money Deposit (EMD) a couple of times, let me explain what that means. A few days after your offer is accepted you will be required to place a certain amount of money into an escrow account. The account is usually held by the title company that is representing the contract. The EMD amount is equal to about 2% of the purchase amount. So, if you are purchasing a home that is $500,000, then you will need an EMD of $10,000.

The EMD is a way for the buyer to show the seller they are placing the offer in good faith. And if the buyer walks away from the contract, for any reason other than what the contract allows, then the seller keeps the EMD. On the other hand, if the buyer completes the purchase of the home and makes it to the closing table, then the EMD is returned to the buyer.

“Earnest money is a deposit made to a seller that represents a buyer's good faith to buy a home. The money gives the buyer extra time to get financing and conduct the title search, property appraisal, and inspections before closing. In many ways, earnest money can be considered a deposit on a home, an escrow deposit, or good faith money.”

The contingencies we discussed are put in place to protect the buyer. When a buyer decides to waive a contingency, they are also putting their EMD at risk. For instance, if a buyer waives the finance contingency and cannot obtain financing, they would be forced to void the contract and lose their EMD.

The same is true when a buyer waives the appraisal contingency. If the buyer is unwilling to cover the difference between the appraised value and the purchase price, then they will lose their EMD.

Buyers must understand the financial risks associated with waiving contingencies. The risks include but are not limited to losing their EMD.

Conclusion

It’s important to understand the entire process of purchasing a home to make your home buying journey less stressful. This means understanding what you are looking for in a home, your budget, and making sure your decisions are not driven by emotions.

The market we are in today can make buyers do things they are uncomfortable with in hopes of purchasing a home they love. Waiving contingencies always comes with risks that will make you feel uncomfortable. Understanding the risks and rewards will allow you to avoid buyer's remorse when your offer is accepted.

Photo by Gabrielle Henderson on Unsplash