Real estate contingencies are important to understand for both buyers and sellers

What does contingent mean in a real estate transaction?

And what does contingent mean on a home for sale?

These questions are quite common and knowing what contingency means and how it can affect a real estate transaction can be confusing.

But, not to worry…

Whether you’re thinking of buying or selling, I’ll explain exactly what all of this means and how you can use it to your advantage.

Here’s what you’ll learn…

  • What contingent means
  • Contingent vs pending (and other statuses)
  • Purchase agreement contingencies
  • How contingencies affect buyers and sellers

What Does Contingent Mean in Real Estate?

First, let’s discuss the definition of contingent in real estate.

When you hear the word “contingent” in real estate or see it on a real estate listing, it means an offer on a home has been made by a buyer and has been accepted by the seller, but the purchase agreement has certain criteria that must be met to finalize the transaction. These criteria are known as “contingencies”.

When a buyer submits an offer on a property, the “contract” is known as a purchase agreement. One of the items the buyer needs to address in the purchase agreement is whether they are submitting a contingent or non contingent offer.

A non contingent offer means the buyer is waiving any and all contingencies. This makes the buyer’s offer look stronger to the seller, whereas an offer that includes one or more contingencies might not look as strong.

I’ll explain why in a minute…

Usually, you’ll see offers without contingencies in a hot real estate market where the supply is low and the demand is high. The reason for this is buyers have competition with other buyers and they’re trying to make their offer look as best as they can.

When a buyer does submit an offer without contingencies, they need to first acknowledge this in the purchase agreement.

Here’s what that looks like on a purchase agreement in California.

 

non contingent offer

 

A separate disclosure is submitted when the buyer releases all of their contingencies. This can happen with their offer (when the buyer is submitting a non contingent offer) or after (when the buyer releases all of their contingencies after submitting a contingent offer).

Here’s what this disclosure looks like in California…

 

contingency removal disclosure

 

What is the difference between contingent and pending?

This question comes up a lot, especially when looking at real estate listings online.

Here’s the difference between a real estate listing that is pending and a real estate listing that is contingent:

Contingent – The seller has accepted an offer from the buyer, but the purchase agreement includes contingencies from the buyer.

Pending – The seller has accepted an offer and the buyer has removed all of their contingencies.

What does active contingent mean?

Active contingent means the same thing as contingent.

Technically, a contingent offer is still an active listing as the chances of it falling out of contract are much higher compared to a transaction that is pending. Most listings that are in contingent status will look at backup offers.

What are the different statuses in a real estate transaction?

  • Active – This means the property is currently for sale and the seller does not have a ratified contract with a buyer.
  • Contingent – The seller has accepted an offer from a buyer but the purchase agreement has one or more contingencies.
  • Pending – The purchase agreement does not have any contingencies from the buyer.
  • Sold – The sale is final and has recorded in the county where the property resides.

A sale can go from active to pending status when the seller accepted a non contingent offer from the buyer. However, it’s more common to see the status change from contingent to pending.

Purchase agreement contingencies

There can be contingencies of any kind in a real estate transaction, but there are three that are most common.

When the buyer is filling in the purchase agreement, they’ll need to state whether they are including each of these contingencies in their offer, and if so, for how many days.

Let’s first discuss the three most common contingencies and then I’ll run through an example of how this all works.

Home Inspection Contingency

The home inspection contingency refers to the timeframe allocated for the buyer to do any and all of their inspections. This can include having their own home, termite, roof, or pool inspector come out to the property. It also includes bringing a contractor out to the home. Any other type of inspection the buyer wants to be carried out would also fall under this contingency. You can think of this as an opportunity for the buyer to do further due diligence on the property.

Appraisal Contingency

An appraisal contingency refers to the time frame the buyer has to not only have their appraisal completed but more importantly, signed off by their lender’s underwriter.

In a hot market, also known as a seller’s market where the supply of homes for sale is very low and buyer demand is very high, it’s not uncommon for a buyer to reduce or even waive their appraisal contingency.

An appraisal contingency usually only applies to buyers who are getting financing. It can also be a part of the contract in an all-cash transaction, but this isn’t that common.

An appraisal is required by every lender and is a condition on the buyer’s loan, as the house is the collateral for the loan amount the buyer is requesting. The bank wants to make sure that the house is worth what the agreed-upon sales price is.

The appraisal contingency is not only important for the buyer, but also for the seller too. If the house does not appraise for the sales price and the buyer has an appraisal contingency in their offer, then three things could happen…

  1. The buyer can try to renegotiate the price.
  2. They can pay the difference.
  3. The buyer can back out of the transaction.

What Happens if the Appraisal is Lower than the Sales Price?

A lender will only use the sales price or the appraised value, whichever is less. A lot of the time, the appraisal will come in at or right around the purchase price. The appraisers know the agreed-upon sale price before they go out to the house. If the value of a home cannot be justified with surrounding comps, then the appraised value may very well be less than the purchase price.

When this happens, the lender will use the appraised value as the amount that they’ll lend on. For example, if the buyer and seller agreed upon a $1,200,000 purchase price and the appraised value is $1,150,000, then the lender will lend on the $1,150,000 – not the $1,200,000. In this scenario, the buyer does not pay the full difference of $50,000. This is a source of confusion for many.

If the buyer planned on putting 20% down on $1,200,000, that means they planned on a $240,000 down payment. If the value from the appraisal comes in at $1,150,000 and this is what the lender is going to lend on, then that means they’ll need to pay 20% of $1,150,000 (which is $230,000) plus the difference of $50,000. This means that the down payment would be $280,000. In other words, if the appraisal comes in lower than the purchase price, then the buyer will need to come up with 20% of the appraised value, plus 80% of the difference between the appraised value and purchase price.

What Does This Mean?

If you’re the buyer in this scenario, this means you will now need to put down $280,000, which is $40,000 more than what you anticipated. This is why having a good agent to assist you with justifying your offer is important. If you’re waiving your appraisal contingency, (which many buyers do in a hot market), then you want to be sure that there’s a good chance that your offer price can be justified by recent sales and the necessary adjustments.

If you’re a seller and you receive an offer without an appraisal contingency, your listing agent should be doing a lot of vetting on the buyer. They should be doing this anyway, but more so when an offer comes in without an appraisal contingency. The key is to make sure that the buyer has enough funds to cover the difference if needed.

Loan Contingency

A loan contingency, also known as a mortgage contingency, is the time frame the buyer has to make sure they’re getting the loan.

Most buyers will get a pre-approval letter from their lender before they make an offer on a home. A pre-approval letter is a great start but it’s not an actual loan approval.

When the buyer’s offer gets accepted, the lender will start the underwriting process. This includes packaging all of the buyer’s loan documents, purchase agreement, title report, etc and sending it to the underwriter.

Once the underwriter looks over everything, they’ll decide if they should issue a conditional approval or not. If a buyer submits a loan contingency in their offer, they’ll usually release it after receiving the conditional loan approval.

What does contingent mean in a real estate transaction?

Now that you know the definition of contingent in real estate and which contingencies are most common, let’s discuss what this all actually means.

As I mentioned earlier, when a buyer is submitting an offer, they must decide if they are going to include any contingencies. If they do, they need to select which ones and how many days they want the contingency. The purchase agreement has a default for the number of days but this can be changed.

For example, let’s say the buyer wanted to include an inspection contingency. In California, the default number of days for this is twenty-one. If the buyer leaves it at twenty-one, then this means they must remove their inspection contingency by the twenty-first day. If they don’t, then the seller can send the buyer a “Notice to Perform”. This means that if they don’t remove the contingency, then the contract is void as the buyer did not perform as they said they would.

If a buyer wanted to make their offer look a little better to the seller, then they could reduce the number of days to anything they wanted.

How can a contingent offer affect a real estate transaction?

As part of a real estate transaction, a buyer will usually include a “good faith deposit”. This is also known as an escrow deposit. This deposit is usually made between one to three days after the seller accepts the offer and is made to escrow.

If the buyer includes contingencies in their offer, they’re able to back out of the transaction during the contingency period and get their deposit back.

If they want to back out of the transaction after all of their contingencies are released, then they run the risk of losing their deposit. This doesn’t mean that they will lose it, but it does mean that they run the risk of losing it to the seller.

Conclusion

Contingencies can play a big part in a real estate transaction.

Price is almost always most important to both the buyer and seller, but contingencies come in a close second.

For a seller, the “big hurdle” is waiting for the buyer to release their contingencies. When this happens, the buyer is pretty much committed and the chances of a successful sale dramatically increase.

The two most important things a seller can do to reduce the chances of having a sale fall through include working with a top agent who knows how to vet the buyer and making the best home improvements. Many reasons why a sale will fall apart is caused by a lack of vetting from the seller’s agent and simple improvements that could have been made before the home was on the market.

For a buyer, it’s always in your best interest to include contingencies in your offer. You’re making a large purchase and you want to make sure that you do all of your homework. This is also why working with a top agent is important. The good ones are not only great at negotiating and helping you find the best comps, but they are experts at knowing what to look out for in order to prevent you from making a mistake for what is most likely your largest financial transaction.