Pros and Cons of Contingencies
In a perfect home buying world, buyers would be pre approved from lenders or would submit cash offers. There would be no appraisal necessary, homes would be pre-inspected, repairs made in advance, property disclosures would be meaningful and we would close in 30-days without contingencies or any hiccups. But in the real world, and according to the NAR 2020 Realtor Confidence Index, roughly 76% of contracts have contingencies. In this blog we explore the most common contingencies and how they affect the sale of a home both from a buyers and a seller's perspective.
What are Contingencies?
Contingencies are conditions within a contract for real property that must be met for the contract to move forward and be binding. If they are not met, a contract or offer is null and void, and earnest money deposits are returned. Contingencies are the most common reason that home sales fall through, while at the same time they can offer both the buyer and seller protections.
North Carolina's Offer to Purchase and Contract
Before we explore the pros and cons of various contingencies, I want to take a moment and remind everyone that every state is different and if you're reading this and buying or selling outside the state of North Carolina you should educate yourself as to the specifics of how contracts in that state are written. The best way of doing this is to simply talk with an experienced professional Realtor
In North Carolina the standard Offer to Purchase and Contract prepared by The State Bar Association and Real Estate Commission that's most commonly used contains a "Diligence Fee" which is a negotiated fee paid directly to the sellers after they have signed a buyers offer. Once the Sellers have signed without making changes; it becomes a contract. The Diligence Fee secures a period of time (typically 2-3 weeks; but negotiable) during which the buyer may have the home inspected, an appraisal if required is done, financing is secured. In short the buyer can "kick the tires." During the diligence period the buyer has the right to terminate the contract for any or no reason whatsoever. If terminated the seller keeps the diligence fee they've been paid and that's it. Seller's should note that it's important that you deposit the buyer's payment promptly as the lender will want to see that it's cleared the buyers account. As long as the buyer closes then the "Diligence Fee" is simply creditied against the sales price
During the diligence period; the buyer may discover some things that impact their thoughts on value (most commonly but not exclusively these are inspection related issues.) The buyer may attempt to renegotiate the contract though both sides need to understand that the current contracts we use clearly indicate the sellers are under no obligation to make any repairs or concessions. Our contract are "AS-IS" and the seller may or may not agree to a buyers request. Any agreement regarding repairs, price reduction or date changes etc. must be put into writing and signed by both parties.
The vast majority of contingencies listed below are covered under North Carolina's Diligence Period and do not get get written in as separate conditions to the contract.
Types of Contingencies
Mortgage/ Financing Contingency
A mortgage or financing contingency may be added to a contract when a buyer has not secured financing. According to the NAR 2020 survey, 41% of closed home sales included a financial contingency and reasons financing may not ultimately be available to a buyer include credit score, income to debt ratio, job, and prior or current liens. A contract with a mortgage contingency becomes null and void if a buyer cannot obtain a mortgage. NOTE: Buyers are well advised to get themselves pre-approved for a loan. This requires turning over to the mortgage lender 2 years of tax returns, a couple of months of bank statements, getting what's known as a Tri-merged credit report and having income and assets verified. Many lenders have taken to telling homebuyers they are "pre-approved" when in fact they are simply pre-qualified which is not the same thing at all. If you've not been asked for and supplied the information above, our suggestion is you've learned something about the lender and that is they're willing to put your money at risk, our suggestion is to find another lender.
Pro: Financing Contingencies are favorable to buyers, because they take a home temporarily off the market during the financing period. The buyer obtains earnest money (different from the Diligence Fee) back in total if they are unable to secure financing and they terminate during the diligence period.
Con: If you are a seller in a sellers market, the fact that a buyer requires a mortgage shouldn't scare you, most buyers do. You'll just want to be comfortable with the amount of diligence money that is being offered for the amount of time the buyer is requesting.
How to avoid a Mortgage/Financing Contingency?
In order to avoid a Mortgage/Financing Contingency, buyers should go to lenders in advance and request pre approval for financing or present an all cash offer. Cash offers are the best for quick closing and even if you do not have cash in the bank, there are third parties that charge interest to present a cash offer in advance to secure a home. The pre-approval process is a great exercise for buyers because it gives them guidance on what they can afford and shop for a home with confidence knowing they are prepared to move quickly as they are fully pre-approved subject only to a contract and a satisfactory appraisal. This allows for a shorter diligence period which is always more attractive to a seller and the length of the diligence period may impact the amount required by the seller as a diligence fee.
Home Inspection Contingency
The home inspection contingency protects the buyer and is the most common contingency in a contract. In 2020, 57% of contracts included an inspection contingency. When there is an Inspection Contingency an accepted offer is only valid the inspection doesn't reveal anything buyer was not aware of and that the problems discovered are resolved by seller or renegotiated in the price. If a home inspection is not passed, the contract may be nullified. A seller has a certain amount of time, outlined in the contract, to correct repairs and pass another inspection or a buyer may renegotiate the price of the home or the contract will be nullified. In North Carolina inspections should be done early on during the diligence period.
Pros: An inspection contingency is in the buyers best interest for obvious reasons. You want to be certain you get a good one. You should also be prepared to share this with the Seller if you are going to request repairs or some form of a price reduction related to inspection issues.
Con: There really is no con other than the cost which depending on the age and size of the home may run between $500 - $1000+ depending on what you're having inspected. Besides the basic inspection a buyer should consider wood destroying insects (commonly referred to as a termite inspection), Radon, Well and Septic if applicable. If the heating and cooling systems are 7+ years old we recommend our buyers also have a separate HVAC inspection done.
How to Avoid A Home Inspection Contingency?
If a seller has a current existing inspection, that satisfies the buyer and buyer agent, then you would not need a home inspection contingency. We do not advise purchasing a home without a recent third party inspection that you've reviewed thoroughly.
Appraisal Contingency
An appraisal contingency exists for the financial safety of the buyer. When a buyer is seeking financing from a lender, lenders will require a third party appraisal of the property to make sure it is in line with the asking price, between 5-10%. Lenders factor comparable properties in the area, property taxes, and third party personal assessment of the neighborhood, renovations, features, finishes, and amenities. If a property is appraised at a lesser value, a buyer may seek to lower the price or the seller may require the buyer to cover the shortfall in cash or the buyer and seller could agree to split the difference in price. Again if this becomes an issue in North Carolina as long as the buyer terminated during the designated diligence period any escrowed earnest money is returned to the buyer in full.
How to avoid an Appraisal Contingency?
Buyers need to be in a position to pay cash. There's no point in a seller having the home pre-appraised as if a buyer needs a mortgage it cannot and will not be considered by the buyers lender; they must order the appraisal.
Sale and Settlement Contingency
Sale and Settlement Contingency is where the sale is contingent on the sale of the buyers home. A buyer needs the sale of their home as equity for financing a new home, so this contingency exists in two parts.
Sales Contingency is when a buyer has not yet marketing their home and is are no offers on the home. The current contract we work with in North Carolina doesn't offer the Seller the ability to ask the buyer to remove this contingency within a limited period of time and terminate the contract with a buyer and return all their money should they be unable to remove this contingency. (Commonly referred to as a kick out clause). In effect a seller who has accepted this as a part of the contract has an open ended contract with no settlement date specified. When the market favors sellers as ours currently does, no seller would consider such a condition.
A Settlement Contingency exists when a buyers home is already under contract but has not yet closed. This is something a Seller may consider as there's a defined date on which the buyer will have either sold their house and received their funds or not. This contingency will likely impact the amount of diligence fee. Our advice to buyer clients is if at all possible negotiate a diligence period that extends a day or two past the settlement date of the home they are selling. If it fails to close they can then terminate during the diligence period which eliminates the need for this type distinct contingency request.
Pro: This is great for a buyer who has found the home of their dreams, but needs to sell their home to obtain financing. It is also good for a seller whose home has been on the market a long time.
Con: If you are a seller and your home has not been on the market long the question becomes, "Do I want to tie my house up and lose the ability to attract other potential buyers?"
Contingencies and conditions on contracts for real estate are protections for the buyer and seller. Leaving out contingencies can be a critical mistake for both buyers and sellers. A licensed and experienced realtor can walk you through each contingency and how they affect the offers you are receiving on your home. Right now in the Triangle, it is a sellers market, and homes are going under contract sometimes in a matter of hours. With so many buyers making offers, it's important to understand the contract you're about to enter. Whether we're working with you as a Buyer or Seller client; we want to make sure that you are getting the best terms and conditions possible. It's just one more reason do not allow a single agent to engage in "Dual Agency".
Thinking about buying or selling a home in the Research Triangle area? Call us, we'd love to help you.
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Posted by Larry Tollen on
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