How Contingencies Protect a First-Time Homebuyer

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First Time Homebuyers Ask: What Are Contingencies, And Why Do They Matter?

When buying a home, there are seemingly hundreds of details to attend to, especially as a first-time homebuyer. Those details can range from the critical to the merely inconvenient, from property lines to pets. One important matter you’ll encounter is that of the contingency.

“Contingencies are your ‘out’ clause,” says Tim Freund, a real estate broker in the Los Angeles area. “They allow a buyer to get out of an agreement legitimately.”

But you want to buy a house, not get out of a deal. What’s that about?

Common contingencies

Contingencies are your built-in buyer protection plan, placing conditions on the sale that ensure you’re not taken advantage of. The most common contingency is a physical inspection, which allows buyers to determine whether there’s an issue with the home that’s bigger than they’re willing to tackle. That could be a leaky roof, a crumbling foundation — or a transmission line buried in your backyard.

Other conditions of a sale can include confirming the seller has clear title — ownership that is not bound by a lien or undisclosed debt.

But Freund says perhaps the most important contingency is loan approval. If you are unsuccessful in qualifying for a mortgage, for whatever reason, you can cancel the deal without penalty. Most importantly, that can mean recouping your earnest money on deposit.

Home value contingencies — and hot markets

Another common contingency, especially in an appreciating market, is the property appraisal.

In a hot market, it’s common to face a bidding war for a house, pitting you against other potential buyers. In that case, you are likely to offer more than the list price. If you win the bid, but the house appraises for a value below your offer, you’ll have to make up the difference between the purchase price and what your home loan will cover.

Freund says there are four possible outcomes in this scenario:

  1. The seller agrees to reduce the price to the appraised value (don’t hold your breath)
  2. You’ll have to kick in additional cash to make up the difference
  3. You and the seller can agree to a compromise sales price plus additional cash
  4. The purchase agreement is canceled

Although contingencies protect the buyer, placing too many conditions on a purchase can take you out of the running for a home, especially in a seller’s market. In such circumstances, Freund says your Realtor might counsel you to shorten contingency time frames, or in some cases even waive the appraisal contingency.

Clearing contingencies

Releasing or clearing a contingency removes a condition of the sale and pushes the purchase process forward. Freund says that’s when a prompt closing becomes important. He gives an example:

Say the buyer of a townhome is approved for a loan, with property inspection and all other due diligence complete. Contingencies have been released, and a 30- or 45-day escrow is in place.

“They get 30 days into it and the stock market drops by 10% — and they just lost their down payment,” Freund says. “So now the buyer wants to cancel. But they’ve lifted their contingencies, which means their deposit is now subject to forfeiture.”

Before lifting contingencies, buyers can legitimately back out of a purchase and, 99% of the time, get their entire deposit back without penalty, he says. That’s why real estate agents prefer quick closings, such as within 30 days — rather than stretching it out to 60 or even 90 days.

Homebuyer beware

Other contingencies include:

  • Inspection and repairs: A qualified home inspector tells you what needs to be repaired or upgraded in the home. You can often negotiate for some major items to be addressed by the seller.
  • The sale of a prior home: You need to sell your home before you buy another.
  • Natural hazards: These are revealed in legally required seller disclosures and can include divulging that a property is in an earthquake zone or flood plain.
  • Insurability: For example, if you find out the property is in a flood zone, can it be insured? And if so, how much will it cost?

Avoiding problems large and small

Some properties are bound by rules and restrictions put in place by homeowners associations, or HOAs. These neighborhood organizations provide amenities and protect property values. That could include maintenance of elevators in a high-rise condo building, or the construction and upkeep of common areas, such as lobbies, clubhouses or playgrounds.

“Maybe the homeowners association doesn’t have adequate reserves,” Freund says. If that’s the case, “every time something needs to be repaired, there’s a special assessment because they don’t have any reserves to pay for the roof or the painting, or whatever it might be.”

But it’s not always major issues that kill a deal. Backing out of a purchase can be a matter of something physical, financial — or even furry.

“Just a week ago, I had a deal fall apart because the homeowners association document said that an owner could ‘reasonably have two dogs on the property’ — and my client had three dogs,” Freund says. “They canceled.”

Contingencies can be a buyer’s best friend.

Hal Bundrick is a staff writer at NerdWallet, a personal finance website. Email: hal@nerdwallet.com. Twitter: @halmbundrick.


Image via iStock.