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Understanding Contingency Clauses in Today’s Real Estate Market
Contingency clauses are provisions in a purchase contract for a home that provide for certain requirements to be completed in order for the sale to proceed to closing. In today’s real estate market, the demand for good quality homes hasn’t fallen much even with high interest rates and inflation. So, what does this mean for home purchase contracts with contingencies?
When there is high demand for a property, sellers may have multiple offers coming in. In the past few years, more buyers are dropping contingencies in order to make their offer more competitive and appealing to the seller. Let’s look at the common contingency clauses, and their value to the buyer and seller.
Common Contingency Clauses and How to Use Them
- Appraisal Contingency
Many mortgage loan types require an appraisal contingency to be present in the home purchase contract because they need to make sure the property is worth at least the indicated sales price to meet loan-to-value ratio (LTV) requirements. FHA and VA loans will require such contingencies.
When can or should a buyer waive this clause? If you’re making a cash offer, you could leave this contingency out. Another option is to waive it if you have enough cash to put towards the home if the appraisal comes up short against the listing price. It’s important to note, a buyer can also reduce the price on the home to the actual appraised value instead of canceling the sale. If you waive this contingency however and the appraisal comes in low, you are still obliged to the original purchase price in the contract.
- Loan/Mortgage or Financing Commitment Contingency
The loan commitment contingency is an important one and specifies how much time a buyer has to secure the financing for a home. You may be wondering, when can a buyer avoid this clause? Most buyers need a loan to purchase a home. If that’s the case, you should include this contingency clause in your contract. However, if you don’t need a loan for a home then you can absolutely waive this clause.
If you’re a buyer, you can sweeten the offer with a pre-approval letter. If you still need a loan, but want to show the seller you mean business, get a pre-approval from your lender to show you can meet the requirements for the offer you’re placing. This will lessen the significance of this contingency clause and may give you an edge over competition.
- Home Inspection Contingency
We’ve all heard of the scary home buyer horror stories. Someone buys a house and doesn’t get an inspection. Then a few weeks after they move in they find termite damage, a leaking roof or a broken foundation! But, did you know there’s usually more to an inspection contingency than just checking the home out from top to bottom. In many cases it includes reviewing disclosures and Natural Hazard Discloser reports.
So, is there ever a good time to waive the home inspection contingency? Maybe, if you are a construction contractor and know your stuff otherwise, No! This is such an important part of the home purchase process and in our opinion not worth the risk. Work with your agent to come up with other ways to make your offer stand out without rolling the dice with your investment. Even new homes need inspections!
- Home Sale Contingency
In some cases, buyers need to sell their current home in order to purchase the one they are making an offer on. This contingency usually sets the date by when that needs to happen. Unfortunately, in a market where homes are in high demand, this contingency can often cause sellers to pass on a contract. If this is the situation you or your client are in, there’s a loan option that they can potentially take advantage of to eliminate this contingency—a bridge loan. According to quickenloans.com, “Bridge loans are a form of short-term financing that can meet immediate cash flow needs during the time between a demand for cash and its availability. While this short-term loan is commonly used in business while waiting for long-term financing, individuals typically only use them in real estate transactions.” Talk to your lender about bridge loan possibilities as not all lenders offer this product.
If a bridge loan won’t work for you, considering trying to sell your current property and “rent-back” to the new owners until you can get into your next property.
Real estate experts understand that no matter how the housing market changes, contingency clauses in home purchase contracts are here to stay. It’s our job to advise our clients on the best approach to these clauses in their contracts. If you’re a potential seller or buyer, be sure to ask your trusted real estate advisors about contingency clauses and your options.
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