If you are considering buying or selling your Waterloo Region home you may have heard or read about contracts that include contigency clauses. And not been too sure about what those are and how they might affect you. As contigency clauses are important - and can 'make or break' any real estate deal they are attached to - understanding more about them is a must, so we are going to take a closer look at them here today.
What is a Contingency Clause in Real Estate?
Contingency clauses provide a way for one or both parties to back out of a real estate contract if certain specified conditions are not met. In other words, the sale is contingent upon these conditions.
Common Contingency Clauses in Real Estate Contracts and What they Mean For You
Some of the most typical contingency clauses in real estate contracts include the ones listed below. It's crucial to keep in mind, too, that a real estate contract may also contain other contingency clauses. And to remember that your best guide to understanding, including or agreeing to any contingency is your real estate agent, who works with them every day.
Home inspection/due diligence contingency clause
The home inspection contingency clause, also known as the due diligence contingency clause, is one of the most frequently used contingency clauses in real estate contracts. This clause gives the buyer the right to arrange for a qualified home inspector to visit the property within a time frame laid out in the contract. It could take five to seven days or longer to eliminate this contingency.
The purpose of the home inspection or due diligence contingency clause is to give the buyer the option to cancel the deal in the event that the home inspector's report is unfavorable. This clause can also enable the buyer to bargain with the seller to have problems noted in the home inspector's report repaired.
Depending on what a home inspector finds, a buyer can negotiate with the seller to determine whether the seller is willing to reduce the previously agreed-upon sale price to offset the expense of fixing significant flaws in the house.
A general home inspector will examine the following areas when conducting a general home inspection:
Exterior inspection (an inspector will be looking at these areas)
Exterior Walls
Foundation
Grading
Garage or carport (if applicable)
Roof, attic, and chimney(s) (if applicable)
Exterior water drainage and water disbursement
Waste systems as applicable
Porches, decks, and patios
Yard/Garden (as applicable)
Wall Coverings
Interior inspection (an inspector will be looking at these areas)
Plumbing
Electrical system
Heating, Ventilation, and Air Conditioning systems (HVAC)
Kitchen appliances
Fire safety
Bathrooms
Lead paint
Interior water drainage and water disbursement
Flooring quality
Noxious gases
Windows and doors
Asbestos
Basements and crawl spaces
Ceilings
You as the buyer will have four options for what to do after receiving the home inspector's report, depending on how the conditions of your home inspection contingency clause are written:
You can acknowledge your approval of the home inspector’s report and what the home inspector found. If you acknowledge your approval of the home’s inspector, this real estate transaction should move forward normally.
You can acknowledge your disapproval of the home inspector’s report and whatever the home inspector uncovered. In this instance, the earnest money you put for a deposit will be returned to you and can back out of this transaction without facing any legal consequences.
You can request the seller to provide you with additional time to have different professionals come and perform additional inspections as needed. You would do this in the event that the first home inspection uncovered something that you need to have further investigated.
You can submit a request asking them to perform repairs or provide you with a concession. A concession is a discount or a benefit a seller might offer a buyer to help cover their closing costs, the cost of new appliances, and/or the cost of making repairs for defects uncovered by a home inspector. If the seller receives the buyer’s repair requests and refuses to honour a buyer’s repair request(s), the buyer would be able to back out of the transaction and have their earnest deposit money returned to them.
In other words, if you have a home inspection done and learn that the home requires more work then you are looking to do, depending on how your offer is written, you might be able to back out of the transaction and have the earnest money returned to you.
Cost-of-repair contingency clause
The cost-of-repair contingency clause is a contingency clause that specifies the amount of money required to perform necessary repairs. For instance, if a home inspector notes in their report that repairs for the home will cost more than a certain dollar amount, the buyer would be allowed to back out of their contract to buy this home.
Ideally, the buyer’s earnest money deposit in this scenario would be returned to them. Frequently, the cost-of-repair contingency is based on a certain percentage of a home’s sale price, such as 1% to 2% of the home’s sale price.
Appraisal contingency clause
The appraisal contingency clause is meant to protect the buyer because it helps to ensure that the property’s fair market value corresponds to a minimum specified amount of money. This helps ensure that a buyer is not overpaying when they are buying a home.
If a professional real estate appraiser performs an appraisal and the property’s appraised fair market value is lower than the minimum specified amount of money for this contingency, the buyer will be able to back out of the transaction.
Ideally, your appraisal contingency clause will be written in such a way that it will force the seller to refund your earnest deposit money. Or the seller can opt to choose to lower the previously agreed-upon sale price for the home to match the amount of money that represents the home’s appraised fair market value.
However, an appraisal contingency might contain language that permits the buyer to proceed with the transaction even if the property’s appraised value is below the specified amount.
This generally happens within a certain amount of days after a buyer has received and reviewed the appraiser’s report with their appraised value for the home. If the buyer wishes to back out of the contract, they will have to back out of the deal within a certain amount of time specified in the appraisal contingency clause.
An appraisal contingency clause will usually include a certain release date, a date on or before which the buyer will need to notify the seller if there are any issues with the appraisal. If the appraisal comes back and the appraised value of the home corresponds with the sale price, the transaction will proceed.
If there are no issues with the appraisal contingency, then the buyer will have been deemed satisfied with this contingency. Once a buyer has been deemed satisfied with this contingency, the buyer will not be able to back out of this transaction.
Financing or mortgage contingency clause
The financing or mortgage contingency clause is another extremely common clause in real estate contracts. This clause states that your offer will be contingent on your ability to obtain financing. The financing clause will specify the type of financing you wish to obtain, the terms of the financing, and the amount of time you will have to apply for and be approved for a loan.
The financing contingency can be helpful for buyers because it protects you if your loan or financing falls through at the last minute. This contingency will allow you to back out of the transaction without facing any legal consequences or losing the money you put up as part of your deposit. The financing contingency is one reason why sellers might prefer working with all-cash buyers who will not need financing in order to buy their home.
The financing contingency protects the buyer because the buyer will only be obligated to complete the transaction if they are to secure financing or a loan from a bank or other financial institution.
Usually, the financing contingency will include an appraisal contingency to ensure that the lender is satisfied with a property’s appraised value. If a lender is not satisfied with a home’s appraised value, they will not issue borrowers a mortgage commitment letter. The financing and appraisal contingency will protect buyers because they ensure that the home is being appraised for the amount of money that it is being sold for.
House sale contingency clause
The house sale contingency clause makes a buyer’s offer to purchase the seller’s home contingent upon a buyer receiving and accepting an offer to purchase their current home. This clause is meant to protect buyers in the event that they are unable to close on the sale of their current home before they close on the sale of their new home.
This means that if buyers are unable to sell their current home for their asking price within an amount of time specified in the contingency clause, they will be able to back out of the transaction without facing any legal or financial consequences.
Sellers, with good reason, might be reluctant to accept an offer contingent upon the buyer selling their existing home and they might only accept such an offer as a last resort. If you are buying in a competitive market where buyers are competing over limited inventory, presenting a seller with an offer to buy their home that is contingent upon selling your current home might work against you. However, if you are looking to buy in a slower market, a seller might be more likely to accept this type of offer.
Offers that are contingent upon the buyer being able to sell their existing home before buying a new home are meant to protect buyers who are looking to sell their home before buying another home. The specific details of any contingency, especially a house sale contingency need to be specified in the Agreement of Purchase and Sale documents. Since real estate contracts are legally binding it is important that buyers and sellers review and completely understand the terms of a house sale contingency.
The house sale contingency clause: what does it mean for you as the seller?
Accepting an offer that is contingent upon the buyer selling their existing home can be risky because there is no guarantee that the buyer’s existing home will sell. Even if your contract allows you to continue to market your home and accept other offers, your home might be as listed as “under contract”. Buyers tend to steer clear of a property that is under contract so they are not wasting their time and falling in love with a home they may never be able to buy.
Before you agree to accept an offer that is contingent upon the buyer selling their current home, the seller or the real estate agent or broker representing the seller should investigate the potential buyer’s current home so they can determine:
If the home is already on the market. If the home is not on the market, this probably is a red flag because this might indicate that the potential buyer is only thinking about selling their current home so they can buy a new home.
If the home is priced appropriately for the market. A real estate agent or broker can put together a list of comparables, based on recent sales of similar homes in the area to ensure that the home has been priced to sell.
How long the home has been on the market. If the home has been on the market for a long time, it is possible that the seller’s asking price may be too high, the procedure to show the home is difficult, and/or the market is slow
The average time that homes in the buyer’s neighbourhood are on the market for. If the average time for homes in the buyer’s neighbourhood is around 30 days, one might expect the potential buyer’s home to sell. If the average number of days that homes are on the market in the potential buyer’s neighbourhood is 90 days or more, the seller could be waiting for the potential buyer to sell their home with a small chance that the potential buyer’s home will sell.
A home sale contingency might be good if the seller’s property has been on the market for a while. If the seller has had a time finding a buyer an offer to buy their home with a house sale contingency is still a contract and there is always the potential that the potential buyer’s home will sell in time.
If you are considering accepting an offer with a house sale contingency clause, it is recommended that you limit the amount of time that a potential buyer has to sell their existing home to one to four weeks. This time limit will put pressure on the buyer to lower their asking price and make a sale.
This time limit for offers with house sale contingencies will prevent the seller from losing too much time if their transaction with the potential buyer does not close. Additionally, sellers can include a “kick-out clause” which will help protect them against a home sale contingency.
The house sale contingency clause: what does it mean for you as the buyer?
In many cases, buyers will need to sell their existing home so they can purchase a new home, especially if a buyer is looking to move into a more expensive home. Therefore, a home sale contingency provides buyers with the time they need to sell and close on their existing home before officially committing to buy a new home.
This helps buyers with avoiding owning two homes and having to pay two mortgages at once while they wait for their current home to sell.
While a home sale contingency can provide buyers with the peace of mind, it does not eliminate the other costs of buying a home. Buyers will still be spending money on home inspections, bank fees, appraisal fees, and other closing costs. And buyers will not be getting this money back if the deal falls through because the buyer’s existing home does not sell on time.
Additionally, buyers are likely to be forced to pay more for a property when they are making an offer that is contingent upon their current home selling than if they had made an offer without a home sale contingency. Buyers are likely to pay more with this contingency because in essence they are asking the seller to bet on the buyer’s ability to sell their current home and the seller is going to expect to be compensated for taking this risk.
The home insurance contingency clause
Lenders and sometimes sellers will require potential buyers to apply for and obtain homeowner’s insurance. This contingency clause is typically included with the fulfillment of conditions and requirements needed to make this happen that will be completed during the escrow process.
The home insurance contingency is meant to protect a potential buyer from property damage, such as fires, natural disasters, and other adverse events. However, actually obtaining homeowner’s insurance in certain regions might be harder than one might expect.
Insurance companies are becoming more reluctant to insurance properties in certain areas and regions. This contingency provides buyers with the option to back out of a transaction in the event that they are unable to secure homeowner’s insurance before closing.
Title contingency clause
During the real estate transaction, a real estate attorney or title company will be doing a title search on the property. A title is important because it serves as a record of ownership and having a title is essential to selling the property. In many cases, any issues related to a home’s title can be resolved before a buyer goes to close on a home. However, there are some cases where title issues could cause challenges for potential new homeowners.
For instance, if there is a lien on the property that needs to be paid before the property is sold. There might be an ownership dispute if the seller is unable to legally prove that they do in fact own the property.
The title contingency is important because it protects potential buyers from these situations because it allows for potential buyers to back out of a sale if these title issues are not resolved before closing.
Things to keep in mind about contingency clauses
Most real estate contracts are contingent on three things:
1. The home inspection/due diligence contingency clause
This contingency clause ensures that buyers have the home inspected and have the chance to review the home inspector’s report before deciding whether or not they want to move forward. This is to help ensure that the buyers will be aware of any defects a home might have so they do not move into a home that is unsafe and/or has major structural issues. This is potentially one of the most important contingency clauses.
2. The financing/mortgage contingency clause
The financing contingency clause helps ensure a timeline for the closing of this sale. A financing contingency is meant to protect the buyer in the event that they are unable to receive sufficient financing that they will still be able to receive a total refund of the earnest money deposit they made when making an offer.
3. The appraisal contingency clause
This contingency clause helps protect the buyer in the event that when the property or home is appraised if its appraised value is lower than the previously agreed-upon sale price the buyer will be able to back out of the transaction. Ideally, in this scenario, the buyer would be able to receive a refund of their earnest money deposit.
Why you should carefully read and review any real estate contract before signing it
Additionally, it is important to remember that real estate contracts are legally enforceable contracts that define each party’s role and obligations’ in this transaction. Contingency clauses will be attached to the contract. You should make sure that you are checking for and reading all of the contingency clauses before signing anything.
When you are reviewing a real estate contract before signing it, you should take note of all of the specified dates and deadlines before signing anything. Time is of the essence in real estate transactions. You might think that one missed deadline and/or one missed day might be no big deal, but this is not the case. One missed deadline or one missed day with contingency clauses could have a negative and expensive impact on your real estate transaction.
Finally, there is usually no limit to the number of purchase contingencies that you can add to your sales contract or Agreement of Purchase and Sale (APS) documents. Agreement of Purchase and Sale documents usually contain a lot of boilerplate and are pretty standardized.
If you are buying a home, you could theoretically include however many contingency clauses your heart desires. As a home buyer are legally allowed to include as many contingency clauses as you want too.
However, it is possible that the more contingency clauses you include might make a seller less likely to want to accept your offer. As a buyer, you need to be careful with which contingency clauses you include and how many contingency clauses you include.
This is especially true if you are looking to buy in a hot market, with a lot of competition between buyers for homes and little inventory of available properties.
If you have questions about contingency clauses, how many to include, which ones to include, and how to proceed when negotiating over contingency clauses relying on the real estate agent or broker who you trust will always be the best way to proceed.
They will be able to explain things to you without the 'jargon' that can be so confusing and ensure that you understand EVERYTHING about the real estate contracts you are being asked to sign so that there are no surprises, or delays, at closing time.
