What Are Contingencies in a Real Estate Contract?
A contingency is a formal clause in a real estate contract that enumerates particular conditions that must be met by either the buyer or the seller in order for the principals to proceed to the next step in the contract. Found in every offer-to-purchase or sell contract, contingencies protect the interests of both buyers and sellers. Failure to meet a particular contingency can result in breach of contract and possible penalties to the party at fault.
Basic Contingencies in Real Estate Contracts
Contingencies are divided into categories according to their purpose:
(1) protection for the seller
(2) protection for the buyer
(3) mutual protection of both buyer and seller. Most real estate contracts contain two universal contingencies: a mortgage contingency and a home inspection contingency.
Mortgage Contingency – The mortgage contingency stipulates that the buyer will make every effort to obtain a mortgage for a particular amount, at a prevailing interest rate within a specified period of time. If the buyer succeeds in obtaining a mortgage as described, the mortgage contingency is said to “be removed.” If the buyer fails to obtain a mortgage, the contingency is unmet and the buyer may withdraw from the contract without penalty. A mortgage contingency therefore protects the interests of the buyer by releasing him from the contract to purchase if financing is unavailable.
Home Inspection Contingency – This contingency protects the buyer because it allows the buyer to withdraw from a contract without penalty, including the return of any deposits made, if the home inspection reveals the house to be unsuitable because of issues like material defects, significant termite damage or dangerous electrical wiring. If the issues discovered are fixable, the buyer has the right to negotiate the repairs he wants with the seller. In turn, the seller may agree to repair everything, a few things or in some cases, even refuse to make any repairs. If agreement on repairs cannot be reached, the contingency cannot be removed and the contract becomes null and void.
Other Common Contingencies
There can be as many contingencies in real estate contracts as there are needs of buyers and sellers. Even though most contracts are boiler-plate, it is more common than not for additional contingencies to be added depending on the protections needed by the principals. In some states it is perfectly acceptable for the real estate agent representing the principal to add contingencies as needed. In other states, only an attorney can add a contingency.
Attorney Review Contingency – One of the contingencies most commonly added by real estate agents is a 24-hour attorney review. This means that after the contract has been signed by both the buyer and seller, the buyer’s attorney has 24 hours to go over the contract and approve it before it becomes official. An attorney review insures the legality of a contract, an important safeguard for both buyer and agent, especially in states where agents may add contingencies as needed.
Sale of Buyer’s Home Contingency – Agents refer to these contingencies as Hubbards. A Hubbard can be used effectively in any type of market; however, they are used more often in a slow market than a normal market. A Hubbard contingency allots the buyer a specified period of time to sell his/her current home before buying the new one. If the buyer’s current house does not sell within the stipulated time (usually 2-3 months) and the buyer does not want to buy the new house without the sale of his/her old home, the contract to purchase the new house is voided without penalty. This protects the buyer from becoming over-leveraged by owning two homes at once.
There is a caveat, however, that provides some protection for the seller. During the period allotted to the buyer for the sale of his/her home, the seller may continue to market the home on which the Hubbard contingency has been placed. If the seller receives a second offer from another buyer that is more attractive than that constrained by the Hubbard, the seller is free to accept the second offer if the first offeror, after being notified, does not want to proceed to closing.
Reverse Hubbard – This contingency gives the seller a specified period of time to locate a new home after an offer to purchase has been accepted. If a suitable home is not found, the seller may withdraw from the contract without repercussions. Just like buyers, most sellers prefer to sell the home they are in before buying another. If sellers have no pressing need to sell and a substitute home that they like cannot be found, they may decide not to sell at all.
Contingencies can be as varied as the circumstances require. For example, suppose you are a buyer and you find a nearly perfect home except it lacks the in-ground pool on which you had your heart set. You wouldn’t mind installing the pool yourself after purchasing the house, but you have no idea if the backyard is large enough to accommodate a pool that would meet all the town requirements of setbacks from the road and from adjoining properties. Your agent or attorney can write a contingency into your offer to purchase that allows you a specified time to investigate the feasibility of installing a pool and permits you to withdraw from the contract should the yard not accommodate a pool.
Contingencies from buyers can include anything from asking a seller to remove a deteriorating shed to installing a new septic system. Similarly, sellers will sometimes present their own contingencies in their offers to sell like asking buyers to allow them to store, for a specific period of time, a second automobile on the property after the sale or making the offer to sell contingent on closing by a particular date.
There are two main points to remember when using contingencies in purchase and sale contracts. First, multiple or unreasonable contingencies by either buyer or seller tend to weaken the position of each. Sellers should require as little as possible from buyers to avoid turning them off and buyers run the risk of having their offers refused if the contingencies are perceived by sellers as off-putting.
The second point to remember is to work with an experienced and licensed real estate agent and a local real estate attorney to ensure that the contract protects your interests. Once you have secured a tight, tidy contract you can relax knowing that your rights are protected.