What are contingencies in Real Estate?
Here in Southern California, you have three main contingencies, Inspection Contingency, Appraisal Contingency, and the Loan (Finance) Contingency. So what are they anyway?
What is it? With an inspection contingency, the buyer has a specific time period during which they must conduct a home inspection after mutual acceptance or contract ratification. Depending on the outcome of the Buyer investigation, the buyer then has a choice to remove the contingency, renegotiate based on findings, or cancel the contract, without losing their earnest money deposit (EMD). Because the buyer has the ability to void the contract based on the inspection report, this contingency is often the scariest from a seller’s perspective. With some types of inspection contingencies, a buyer can also request repairs from the seller as a condition of the purchase; this can also be off-putting for the seller.
What is it? The appraisal contingency allows the buyer to renegotiate or walk away from the deal if the appraisal comes back lower than the ratified price. The appraisal is an independent assessment of the value of the property and is required by any lender. The appraisal contingency and the loan contingency are interconnected because your lender will base your loan amount on the appraisal value, or the ratified price, whichever is lower. For example, if you are making a 20 percent down payment on a $500,000 home, your lender has agreed to loan you 80 percent of the home’s value, or $400,000. If the appraisal comes in at the value of the home or higher, then those numbers stay the same. But if the appraisal comes back saying that the home is only worth $450,000, the bank will still loan you 80 percent, but 80 percent of the lower value, and thus will only loan you $360,000. You are still under contract to pay $500,000 for the home, and so you’ll have to come up with the difference or use one of the options the appraisal contingency offers, which is 1- void the contract, 2- accept it and increase your down payment, or 3- renegotiate with the seller.
To waive or not to waive? Each situation is unique, but I don’t often recommend waiving the appraisal contingency if you are financing the purchase. If a buyer is set on purchasing a particular house and is willing and able to increase the down payment if the appraisal comes back low, then waiving this contingency can strengthen an offer.
What is it? The loan contingency says that your purchase of the home is contingent on securing financing within a set period of time, and the buyer sets the length of the contingency in the contract. It protects you in case something goes wrong and you are unable to get a loan. As I mentioned above, the loan contingency is intricately tied to the appraisal.
To waive or not to waive? If you are paying all cash for a home, you would certainly waive this contingency. If you aren’t paying all cash, waiving the loan contingency can be risky for some buyers, especially when purchasing at the upper edge of their affordability. If for some reason your loan falls through, you would still be legally obligated to purchase the home; this contingency can protect you in this unlikely event. The loan contingency could be your only protection if something unforeseen happens, such as the loss of a job. It is important to understand all these contingencies and what they mean in your individual situation.