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What Are Contingencies?

05/21/20  |  Kyle McCullough

Terms of the contract.

 
 
The purchase contract for a home includes two primary components: price and terms (contingencies). A contingency can also be described as the subject to terms of the contract and allows a buyer to present an offer subject to a term or series of terms. For example, a buyer presents an offer of $800,000 subject to a contingency or multiple contingencies. If the offer is accepted, the buyer will have a specified time frame to execute any contingencies. Then if a specified contingency is not satisfied, the buyer has a safe-exit to cancel the purchase contract.
 
Per the financial terms of the CAR and SFAR purchase contract, upon acceptance of an offer, the buyer puts down 3% of the purchase price as an EMD (earnest money deposit) to kick off the transaction, and to show good faith entering the transaction. This is due within 1–2 business days of acceptance, and goes to the escrow/title company — the neutral facilitator of the transaction. **3% is the norm in the Bay Area, and can vary in other markets, properties, or situations.
 
A contingency will give the buyer a safe-exit to cancel the purchase contract and protect their EMD.
 
FAQ: Is the EMD immediately returned to the buyer? — For the EMD to be returned to the buyer, it first needs to be “released” from the escrow/title company. Since the escrow/title company is a neutral third party, they don’t have decision power. Releasing the EMD will require signed mutual agreement from the buyer and the seller.
 
A non-contingent offer is when the buyer has waived all of their contingencies. If the buyer decides to cancel the purchase contract, the seller may take action to obtain liquidated damages up to 3% of the purchase price… the value of the buyers 3% EMD. In this situation, now the seller will have to pay additional marketing, staging, and holding costs. Also, the seller will have collected more days on the market and will have to find a new buyer.
 
The San Francisco Bay Area is a competitive sellers market where multiple offers are the norm. The winning buyer has often waived all of their contingencies, and cannot cancel the purchase contract without the risk of losing their EMD. Think of this as going “all in” with the offer.
 
Removing or waiving contingencies is 100% the buyers choice. Agents, lenders, or other professionals should not advise a buyer to waive any contingency.
 

Below we will breakdown the 3 common contingencies, plus what aggressive buyers are doing to present a non-contingent offer.

 

1. Inspection Contingency

 
The time period to have a professional home and pest inspection, and verify all material known facts about the property including condominium HOA documents. Buyers are always advised to perform as much due diligence as possible to satisfy themselves with the purchase of the home.
 
Including the inspection contingency: protects the buyer if any red-flags or unforeseen repairs arise during the home inspection. Then the buyer has a safe-exit to cancel the purchase contract.
 
Waiving the inspection contingency: indicates the buyer is waiving their option for further inspection and proceeding with the property in its current condition and the provided disclosures. This will be paired with a Buyers Inspection Waiver form for the buyer to confirm they are going outside the advice of the agent and broker. The buyer cannot cancel without risking the EMD.
 
Aggressive buyers are touring properties as soon as they go on the market and learning as much as they can about the property prior to submitting an offer.
 
The SF Bay Area is a unique market where disclosure packages are provided upfront so interested buyers can review nearly everything before submitting an offer. This makes it easy for interested buyers to do their homework ahead of time. Though it’s not required, it’s also common for sellers to provide professional home and pest inspection reports in the disclosure package. The goal for the seller is to filter out the not so serious buyers and receive more serious offers to reduce the risk of having to go back on the market because of a cancellation.
 
FAQ: Can we trust the inspection reports provided by the seller? — Professional inspectors are hired as a third party to provide a detailed unbiased report of the functionality along with immediate concerns, considerations, and further investigations recommended with the property. Everything from a busted door handle to replacement of the water heater to water damaged wood. Buyers are always advised to do as much due diligence as possible to satisfy themselves with the purchase of the home.
 
In some situations, the buyers may opt to do a pre-offer home inspection. In other words, hiring a home inspector before making an offer. The pros: get your own professional opinion beforehand. The cons: paying for inspections before knowing the home is yours.
 
If the buyers are satisfied with the provided disclosure package, reports, and the condition of the home, they might feel confident waiving the Inspection Contingency.
 
On that note, buyers are always advised to have their own inspections and walk the property with the home inspector.
 

2. Loan Contingency

 
The time period for the lender to process the application and verify the buyers financial profile for full loan approval.
 
A loan pre-approval letter is usually attached to an offer presentation. This shows the seller that a lender has done a preliminary review of the potential buyers financials, and has provided a written pre-approval letter. At this stage, the loan officer or lender point of contact has reviewed the buyers financials. Often processing the loan application through an AWS (automated underwriting system). Once there is a ratified contract, the lender will often need 25–30 days to complete underwriting and process the final loan approval.
 
Including the loan contingency: protects the buyer if they cannot obtain the loan, and provides a safe-exit to cancel the purchase contract.
 
Waiving the loan contingency: indicates the buyer is confident and has peace of mind to obtain a loan. The buyer has waived the option to cancel the purchase if a loan cannot be obtained, and canceling the purchase may risk the buyers EMD.
 
Aggressive buyers are obtaining a full underwriter loan approval before making their offer.
 
At this stage, the loan is mostly approved. The other remaining pieces include approval of the appraisal report, title report, and HOA review which happens after there is a ratified (accepted) offer contract. There is a low risk of the buyer not being able to get the loan and may feel confident waiving the loan contingency.
 
Every lender has an underwriting department which is the black/white authorization of approval. This step takes a little more time, but it is well worth it. Once there is a ratified contract, the lender will often need 14–21 days to close. The shorter closing period adds to a more attractive offer.
 
Pro Tip: When pursuing a condominium purchase, or a property that has an HOA — ask your lender if they have closed any loans recently in that development. If the answer is yes, then the lender has already approved the HOA. If not, or if the approval is out-dated, then a full HOA review will likely be necessary.
 

3. Appraisal Contingency

 
When there is a loan, the bank will have the home appraised to confirm the market value in relation to the buyers purchase price.
 
The risk here is when the appraised value comes in lower than the purchase price. Example:
 
You offered $800,000 on the home, and the seller accepted the offer. The appraisal report comes back with a value of $750,000. Now the bank will only loan the appraised value of $750,000, and there is a $50,000 difference for the buyer to proceed with the purchase.
 
Including the appraisal contingency: protects the buyer in case the home does not appraise at the agreed purchase price. In the example above, the buyer has a safe exit to cancel the purchase contract if the buyer cannot make up the $50,000 difference.
 
Waiving the appraisal contingency: the buyer will be responsible to cover the difference, and cannot cancel the purchase without risking the EMD.
 
Before making an offer, the buyers agent should be providing a comparable sales report to help analyze what the real market has paid for a similar home in the recent few months. This will help gauge the market value based on real-time similar home sales.
 
Aggressive buyers have an understanding of comparable market sales, local market trends, and competition. They are often confident with their budget to make up the difference if the appraisal comes in under.
 
Appraisers will also review comparable sales, take measurements of the home, check for habitability, learn how many offers were received, and more to generate the appraisal report and value.
 

Key Takeaways

 
  • Contingencies are the “subject to” terms of the purchase contract and protect the buyers EMD (earnest money deposit). Contingencies provide a safe-exit to cancel the purchase contract if any of the terms are not satisfied.
  • The EMD requires mutual agreement to be released from the escrow/title company and be returned to the buyer.
  • In a competitive market, aggressive buyers are not waiving contingencies blindly. They are taking a few extra steps to position themselves in the most confident way possible.
  • Inspection, Loan, and Appraisal are the 3 most common contingencies. There are other smaller contingencies such as the Title Contingency, Contingent upon the Sale of Current Property, as well as custom contingencies more specific to the buyers situation.
  • Removing or waiving contingencies is 100% the buyers choice. Agents, lenders, or other professionals should not advise a buyer to waive any contingency.



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