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

Understanding the answer to what does contingent mean in real estate is critical whether you’re a buyer or seller. It’s undeniably a pivotal part of the home selling and home buying process.

So, exactly what does a contingent offer mean in real estate? A contingent offer occurs when an offer on a home has been made by a home buyer and has been accepted by the seller, but the contract has certain criteria that must be met to finalize the transaction.

For a contract to be binding, a condition put into the contract needs to be met first. This is also referred to as a contingency.

In this article,  I’m going to outline everything you need to know about contingencies. This includes how real estate contingencies can protect you and how you can use them as leverage when selling or buying your home.

How Many Contingencies Can be in an Offer?

Technically, there can be contingencies of any kind in a real estate transaction. But there are three you’ll be most likely to hear about. These include an inspection contingency, an appraisal contingency, and a financing contingency. These contingencies are standard on the purchase contract in California, and are also common in most other states.

Sometimes, a buyer makes an offer on a home for sale that is contingent on the sale of their current residence. This type of contingency isn’t as common, particularly when market inventory is low and demand for homes is high.

This type of market is known as a seller’s market. It generally means there are more buyers than there are homes for sale. Because of this, buyers need to stay competitive with their offer. This is due to the fact that sellers often will have several offers to choose from. This usually means that a buyer won’t be placing a contingency that would take up more time for the seller. The sale of a buyer’s current residence that is placed as a contingency in an offer is usually more common in a less competitive market.

How do Contingencies Work in Real Estate?

When a buyer is thinking about putting an offer on a home, the first thing they do is their homework. This includes researching nearby recent sales, and requesting to look at all of the seller’s disclosures, reports, and inspections. Most buyers will ask their agent to gather this information. Then, the buyer and their agent will thoroughly go through and do as much research as possible.

When the buyer is ready to put the offer together, they’ll discuss which terms they would like to include. The two biggest ones involve price and the contingency periods. In California, there are standard time frames for the contingencies – but the buyer has the option to reduce the timeframes, or waive them altogether.

When selling your home, you shouldn’t only look for the highest price being offered. You should be looking at the contingency periods as well. Sometimes the highest price isn’t always the best offer.

Here’s an example to illustrate this point. Imagine a scenario in which two prospective buyers have placed an offer on a home. One buyer offered $1,250,000 and waived all of their contingencies. The other buyer offered $1,260,000, but kept their inspection and appraisal contingency.

Real estate contingencies should be considered along with price when evaluating offers from buyers.

Which one would the seller be more inclined to accept? The seller’s agent should be going over the details, including pros and cons in a scenario like this, but this is an example where contingencies in a real estate transaction can influence a seller’s decision on an offer.

Where Escrow Comes In

One of the biggest effects and influences of contingencies in a real estate transaction has to do with the escrow deposit. This is not only the case in California, but also in many other states across the country. When the contract is ratified, the buyer needs to put a deposit in escrow within 72 hours. This is because 72 hours is the default timeframe, but this can be cut down to less time if the contract says so. This deposit is usually 3% of the purchase price and is applied to the buyer’s down payment.

There’s a key piece of information to note if you’re a buyer. In order to have your offer look a little more enticing to the seller, state that you’ll deposit the 3% within 24 hours. If you’re a seller, your agent should be a little aggressive. They may see if they can get the buyer to make the escrow deposit within 24 hours instead of the standard 72.

Once the buyer removes their contingencies, their deposit can be at risk. This means that if the buyer wants to back out of the transaction after releasing their contingencies, then they may be at risk to losing their deposit to the seller.

If the buyer still has contingencies in place, and wants or needs to back out for a specific contingency reason, then they can do so and get their deposit back. You’ll want to confirm what is specifically stated in your contract. Your agent should be able to go over this with you.

Next, let’s break down each of the big three contingencies in real estate that are the most common.

Home Inspection Contingency

The home inspection contingency refers to the timeframe allocated for the buyer to do any and all of their inspections. This includes 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 carried out would also fall under this real estate contingency.

When selling a home, the seller needs to disclose as much information about the house as possible. Anything and everything they know, whether good or bad, will need to be detailed in standard disclosure forms.

The seller’s agent will provide these standard disclosure forms to the seller to fill out. These disclosure forms, along with any reports and inspections the seller has done, should be put together by the seller’s listing agent. They should be easily accessible for any buyers and their agents by the time the house goes up for sale. This can be done in several different ways. Some examples include putting a link directly on the MLS that only other agents can access or having a Dropbox or Google Drive link ready to share. They can also be sent via email with attachments.

Along with the disclosures, the seller will need to provide certain reports. The two most common ones in California are the title report, also known as the prelim (short for preliminary title report), and the Natural Hazard disclosure.

Preliminary Title Reports and Natural Hazard Disclosures

The title report is the legal description of the property. It documents who the current owners are, any liens on the property, and encroachments. It also documents easements, the current tax rate and instalments for the current owner, as well as how the current owners are vested.

The natural hazard disclosure is a report that is required in the state of California that the seller must provide. The disclosure will state if the home being sold lies within a hazard area. There are six of them that must be disclosed. They include a special flood hazard area, and dam inundation. They also include very high fore zone, wild land fire, earthquake fault zone, and a seismic hazard. As a side note, if the property does fall within one of these hazard areas, most lenders will require extra insurance that the buyer will need to purchase.

A natural hazard disclosure is a report that is required along with any disclosures that are part of the home inspection contingency.

In addition to providing the required disclosures and reports, the seller has the option to have any inspections done on the property that they’re selling. If you’re a seller, you might be thinking that this is a waste of money. In fact, the opposite is true.

Two Reasons For Getting Inspections Upfront

It’s in your best interest to complete inspections on your home upfront for two reasons. One, if there are any major problems that arise from these inspections you will know about it and decide if you want to tackle it before you put the house up for sale. But the second reason, in my opinion, is the most important. The buyer will have the opportunity to see these inspections before writing their offer. This is huge and can pay off for you in a big way.

If you’re a home buyer and you’re doing your research on a home that you’re interested in, wouldn’t you be a bit more educated on the property and be able to make a more informed decision on your offer because you have this information upfront? Chances are, you would – and most buyers do.

In California and especially in Silicon Valley, home, termite, roof, and pool inspections are the most common. Again, these are optional for the seller, and either way, the buyer will have the option of doing their own inspections once the contract is ratified. But it’s in everyone’s best interest if these are provided upfront.

A Firsthand Example

As a seller, your agent should be able to leverage these inspections and negotiate a better offer. I just sold a house in Almaden Valley, which is an upscale neighborhood in San Jose. My clients were adamant about not doing inspections upfront. They purchased their house in 1985, and said when they bought it, the seller didn’t provide any inspections and that they had to pay for them. Why should they have to conduct inspections for a new owner? I explained how the buyer would most likely include a home inspection contingency in their offer if we didn’t provide one upfront. Eventually, they decided to get a home and termite inspection.

Both reports came back very clean, with only the home inspection having a few minor recommendations. Because we had the inspections upfront, this helped the buyer feel more comfortable in writing the terms of their offer. This also helped me negotiate their offer $100,000 above our asking price without any buyer contingencies. The buyer did all of their homework and decided to use our inspection reports in their decision of waiving their contingencies with their offer.

Needless to say, having these inspections done upfront helped the seller get an offer that they may not have without them. It also helped the buyer get their offer accepted on a home that they really love.

Sell your home for the highest price at only a 4% real estate commission

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 underwriter at their lender.

In a hot market (like the one we’re in now in Silicon Valley), 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. But it can also sometimes be a part of the contract in an all cash transaction. This, however, is not 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. One, the buyer can try to renegotiate the price. Two, the buyer can pay the difference. Or three, the buyer can back out of the transaction.

The Importance of Comparables

If you’re a buyer, you want your agent to pull comparables and do their homework. They will want to look at what has recently sold in the area before writing your offer. A good agent will not only pull the comps, but will also make adjustments. This is similar to what an appraiser would do. When comparing the subject property to what has recently sold, some of these comparables might include the condition of the home and the location of the home on the street. Why is the location on the street important? If a home is on a corner, by a stop sign, or on a busy street, the value can be 3-10% less than it otherwise may be. Comparables may also include certain upgrades to the property, as well as proximity to good schools.

You and your agent will also need to take into account the most recent trends in the neighborhood. Is there a very low supply of homes, and are they selling quickly? If so, then you should factor in a small percentage increase in value compared to a home that sold 3-6 months ago. Doing your homework and working with an experienced agent who knows how to make these adjustments can only help you in making a more educated decision on your offer price.

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 get a copy of the purchase contract 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 comes in at $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 tehy’ll need to pay 20% of $1,150,000 (which is $230,000) plus the difference of $50,000. This means that your 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 price in a seller’s market is important. In many cases, the offers are above the asking price. 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.

Why Vetting the Buyer is Important

Let’s say you’re selling your home, and you get an offer for $1,500,000. Your agent gets the offer, the signed disclosures and reports, the buyer’s pre-approval letter, and proof of funds for the 20% down payment. In Silicon Valley, submitting these items with an offer are pretty standard. In other parts of California and in other states, it’s not as common.

Now, let’s say you accept the offer. Next, the buyer puts down their escrow deposit and the lender orders the appraisal. But the appraisal comes in at $1,440,000. Does the buyer have enough funds to pay the difference? You and your agent aren’t sure, because your agent didn’t confirm this beforehand.

Your listing agent should always ask the buyer’s agent if the buyer has any more funds. They should also ask what happens in a scenario where the appraisal comes in less than the purchase price. If the buyer only has enough funds for the 20% down payment, then this is something you’ll need to take into consideration when looking at their offer.

Loan Contingency

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

A loan contingency is not the same thing as a pre-approval. When a buyer removes their loan contingency, they’re just about 100% certain that they will have no issues with the loan.

When a buyer receives pre-approval, they usually submit their most recent pay stubs, tax returns from the previous two years, and their most recent bank statements along with their loan application. Depending on who the lender is, the loan officer may issue a pre-approval. In other cases, it will come directly from an underwriter. It’s ideal if the buyer gets the pre-approval after having an underwriter look at their initial loan documents.

The underwriter is the person at your bank who is looking over all of your loan documents. They are the decision maker. A pre-approval will still have outstanding conditions such as the purchase contract, appraisal, and title report, among others. But when the pre-approval comes directly from the underwriter, all parties involved can be a little more confident that the buyer will be able to obtain financing.

What Happens Next?

After the contract is ratified, the first thing the buyer and their agent will want to do is tell the loan officer of the offer’s acceptance. The loan officer will start the loan process right away. First, they will need a copy of the contract, the title report, and the escrow company information.

At this point, the buyer’s loan is conditionally approved. This means the lender is going to approve them, but only after they meet a certain number of conditions. Once they meet all of these conditions, then the lender will draw the loan documents and get them ready for the buyer to sign. This process can take anywhere from 20-30 days.

When the buyer releases their loan contingency, they want to be 100% certain that there will be no issues with the loan. Before a buyer waives their loan contingency, they should have a discussion with their loan officer. They will want to tell them that they’re removing their loan contingency and will also want to make sure that the loan officer gives them the green light.

As a seller, your listing agent should be doing a lot of vetting when you receive an offer. Much like asking for proof of additional funds, the seller’s agent should make a phone call to the loan officer and have brief discussion with them about the buyer’s financing situation. This can give the seller and the listing agent a clearer picture on how just how well qualified the buyer is.

What Does Contingent Mean in Real Estate?

So, how does one sum up the answer to the question “What does contingent mean in real estate?” The biggest takeaway to remember? You shouldn’t count on the transaction being close to complete until the removal of all of the contingencies.

Contingencies in real estate are important for both buyers and sellers to consider.

If you’re a buyer, make sure to do your homework and have contingencies in your offer. This of course could vary depending on what kind of market you’re in. Regardless, I always suggest to my clients that they should have an inspection contingency at the very least. And depending on the situation, I almost always suggest an appraisal contingency as well. In a tumultuous seller’s market, like the one Silicon Valley has been in for some time, often the buyer doesn’t have a choice but to waive all of their contingencies. In a neutral market or a buyer’s market, the opposite is true. Because the number of homes for sale is higher than usual and the demand isn’t as high, home buyers have more leverage.

What You Should Do as a Seller

If you’re a seller, make sure your listing agent is doing a considerable amount of vetting on the buyer and their offer. Make sure they’re calling the loan officer for the buyer before you decide which direction to go with the offer. Also make sure they’re playing through every scenario. For instance, if the appraisal comes in short and there’s no appraisal contingency, can and is the buyer willing to pay out of pocket? Do they have pre-approval from an underwriter? Or did a loan officer issue it?

As a seller, your listing agent’s job is negotiate the best possible terms in the offer you accept. This doesn’t always mean price. Sometimes, an offer with strong contingencies, but lower price compared to another offer can be better. One important thing to remember: don’t celebrate until all contingencies are released from the buyer. In fact, don’t celebrate until your home sale proceeds hit your bank account. Never count on the sale of your home almost being completed until the buyer has released all of their contingencies and the appraisal is completed without any issues.

If you’re thinking of selling your home and live in Silicon Valley, your neighborhood SoldNest agent can sell your home for more and save you thousands. Not only can we help ensure you receive the best possible offer in terms of both price and contingencies, but we also provide better overall service and marketing – and only charge a 4% commission. To see what your home might sell for, we’ll provide you with a thorough market analysis. You can request one here.