After the escrow process, it’s time to plan for common contingency clauses.
This is part two of a three-part series on purchasing a home. ExplorePart 1: Escrow and earnest money and Part 3: Closing your home purchase.
As always, the lending team at Fremont Bank is happy to provide assistance and answer any questions.
Understanding contingencies
Contingencies are like safety nets for homebuyers. Imagine you’re planning a big event like a wedding. You want everything to go smoothly, but there’s always a chance that something unexpected might happen. To protect yourself, you put certain conditions in place called contingencies.
In the context of buying a home, contingencies are clauses in the purchase agreement that allow you to back out of the deal or renegotiate certain terms if certain conditions are not met. They give you the flexibility to protect your interests.
Work closely with your real estate agent to include the appropriate contingencies in your purchase agreement to safeguard your interests as a first-time homebuyer.
Four contingencies first-time homebuyers can consider:
- Inspection contingency: Allows you to hire a professional home inspector to thoroughly examine the property. If any significant issues are discovered, such as structural problems or major repairs needed, you can negotiate with the seller to either fix the issues or adjust the price accordingly. If an agreement cannot be reached, you can back out of the deal without any penalties.
Typically, the window for home inspections is the shortest, usually only a couple of days, as the seller will have a report ready for review as part of listing the property.
- Appraisal contingency: When you apply for a mortgage, the lender typically requires an appraisal to determine the fair market value of the property.
The appraisal contingency ensures that you’re not overpaying for the property. You can renegotiate or back out of the deal if the appraised value is lower than the agreed-upon purchase price. The contingency window is typically 7-10 days, depending on the appraiser’s schedule.
- Financing contingency: Buying a home is a significant financial commitment, and it’s important to ensure that you can secure the necessary financing. A financing contingency allows you to back out of the deal if you’re unable to obtain a mortgage or if the terms of the loan are not favorable.
This contingency protects you from being stuck in a situation where you can’t afford the home. To reduce the risk of this situation, it’s important to work with a financial partner who understands your timelines and budget and can deliver.
- Home sale contingency: If you’re currently a homeowner and need to sell your existing property before buying a new one, you can include a home sale contingency.
This contingency gives you a specified time to sell your current home. If your home does not sell within that time frame, you can back out of the purchase agreement.
As you move through each step, you remove the corresponding contingency. Use the advice of the real estate agent and loan officer to help you make decisions.
Once all contingencies have been removed, the earnest money deposit technically becomes the seller’s property. If the buyer later walks away from the home after contingency removal, they cannot be refunded the earnest money. This is an especially important negotiating tactic.
Seller’s market
In a seller’s market (meaning there is more competition among buyers), there is more pressure to submit non-contingent offers. Remember, in this case, the earnest money deposit becomes the seller’s property as soon as it is deposited with Title. A non-contingent offer leaves little recourse for the buyer should something come up later in the inspection report, appraisal, or financing process. It is never recommended that all contingencies be waived. At a minimum, put one in place to ensure an adequate due diligence window to review the transaction to make sure the buyer wishes to move forward post contract signing.
Understanding reports
A range of reports provide critical information about the property and can help determine if a contingency can be removed. Let’s dive a little deeper into each of the reports and what their purposes are.
Home inspection
Your real estate agent works with you through the review of the home inspection report and any other disclosures about the property and negotiations necessary based on findings. These provide a more comprehensive understanding of the working pieces of the home like the air conditioning, roof, and furnace.
Depending on how the inspection looks and if anything needs to be repaired or replaced in the near future, you may be able to negotiate a seller credit for some of the required work. The lender will request a copy if needed but, in most cases, they will not want to see the home inspection report.
Appraisal
The appraisal provides a third-party professional’s opinion to make sure the home value supports the purchase price. Good appraisers understand the local markets and current market conditions around value.
This report is different from a home inspection. An appraiser is not doing a deep review of all the mechanical aspects of the home. Rather, they give a high-level walkthrough and comparison to other homes in the neighborhood. If the appraiser sees obvious signs of deferred maintenance or health and safety issues, these may be called out on the report and require repair or a deeper inspection. Based on information gleaned, the lender may require roof and pest inspection reports.
If the appraisal comes back lower than the purchase price, you have the following negotiation options with the seller:
- You agree to come up with the difference. The financing would be based on the lower of the appraised value or the purchase price. This increases the required down payment.
- You provide the appraisal to the seller to see if they will reduce the purchase price. If they agree, the purchase agreement will be updated with an addendum changing the purchase price. This saves you the difference.
- You meet halfway and split the difference between buyer and seller.
The choice really comes down to whether you feel the home is worth it and how you and your real estate agent want to pursue the renegotiation.
Note: If you don’t want to negotiate and have an appraisal contingency, you can walk away from the purchase. If you waived the appraisal contingency, the purchase moves forward and you will come up with the difference as outlined in the first option.
Pest, roof, and other inspection reports
Additional reports can confirm damage or maintenance needed for various aspects of the property. Necessary repairs typically need to take place prior to closing.
Issues with pests, roofs, and other inspection reports can require renegotiation, credits, and even escrow holdbacks to keep the deal moving forward. If needed, talk to your loan officer to order any of these to properly prepare for any issues.
With contingency clauses removed and reports reviewed, it’s finally closing time. We have all the details on closing in our next post.
Wherever you are in your purchasing journey, the team at Fremont Bank is ready to help.
