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Using Contingencies in a Purchase Agreement

If you bought or wrote an offer on a property on the Peninsula in the last ten years, you may not have even heard the word “contingency” before, let alone understand how it relates to an offer. When buying in a red hot market like the Peninsula has been, many homebuyers will write offers with zero contingencies attached to it. So what is a contingency?
 
A contingency is something that is written into a contract which protects a buyer and allows them to back out of the contract if certain events or circumstances do not occur. 
 
Since certain outcomes cannot be predicted, a buyer can use a contingency to protect their 3% deposit as well. For example, an inspection report may indicate that there may be foundation issues with a home. A buyer can write an offer contingent upon an additional foundation inspection. If the report comes back with anything that makes the buyer uncomfortable, they can back out of the deal without loss or penalty or choose to renegotiate.
 
It is important for home buyers to understand contingencies and how they can affect their offer. There is no limit to how many contingencies can be used but buyers must be aware of the market conditions and understand whether or not other buyers are using contingencies.
 
The most common contingencies used on the Peninsula are listed below: 
 
  • Financing - This is a contingency used by buyers who are obtaining a loan for the purchase. In our current market and area, buyers will submit with their offer a pre-approval letter from a lender. The lender states that they have approved the buyer for a certain loan amount but in some cases the lender may request additional days. If this is the case, it may be a good idea to use a financing contingency with your offer. The problem is that a loan can fall through sometime between the offer being accepted but before the close of escrow. This is where a financing contingency would protect the buyer.
  • Inspection - We typically see full disclosure packets with all or most of the inspections done. This is due to the fast pace in which real estate transactions occur here in San Mateo County. However, whether the inspections are provided or not, the buyer has the right and is encouraged to conduct their own inspections on a property before buying. Writing in an inspection contingency gives the buyer a chance to order a property inspection, pest inspection, foundation inspection, etc. to satisfy themselves as to the condition of the property. 

  • Appraisal - Once an offer is accepted, an appraisal is ordered and sent to the lender. Mortgage lenders will then use the appraisal to make sure the property being purchased is worth the amount the buyer has agreed to pay. Sometimes the appraisal comes back and values the home at less than the agreed upon sales price. When this happens the buyer can either make up the difference or risk losing the initial 3% deposit. With an appraisal contingency a buyer protects their deposit and is able to back out of the contract.
  • Sale of Current Home - Oftentimes, buyers want to first know which home they are going to buy before they decide to sell their current home. The problem is that unless they are all cash buyers or are pre-approved for a loan on a second house, they are going to have to make any new purchase contingent on the sale of their home.  Put yourself in the position of a seller: you receive three offers on your home and one of them is contingent on the sale of their home. Are you going to roll the dice and bet that their home is going to sell quickly and without any problems? For this reason, buyers may try to sweeten the pot by overpaying any other offers because they understand this contingency may make theirs less attractive.
  • Title -  The title is the official document that records the history of ownership for a property. Once in contract, the title company will make sure there are no clouds on the title and that it is free of any liens, legal disputes or any other issues. Most title issues can be resolved during the escrow period before the closing but sometimes title issues are more problematic. Using this contingency will allow the buyer an out. Note: Keep in mind that these are not the only contingencies that can be included in a purchase agreement but they are the most common on the Peninsula.
Remember that contingencies cut both ways. Yes, they do protect buyers, but it can also weaken their offer. Using contingencies is not uncommon but when considering which, if any, to use, it is best to consult a local expert. Knowing your market will increase your chance of writing a winning offer.

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