How to weigh the costs of contingencies
Contingencies are a set of terms in your contract that allow either the buyer or seller to cancel the agreement if the terms aren’t met. These can vary but common contingencies may be related to inspections, financing, and repairs. For example, a buyer may ask for a contingency that allows them to back out of a sale if both parties can’t agree on repairs following an inspection.
In hot markets, you may encounter buyers waiving contingencies as a way to make the deal more appealing. Conversely, in a buyer’s market where there’s not a lot of competition for your home, buyers may ask for more contingencies since they run a lower risk of their offer not being accepted.
While contingencies can protect a seller’s needs, they also protect the buyer’s needs to allow them to cancel the deal or negotiate on price based on items that come up during the escrow or closing period.
Inspection contingency
This contingency provides a way for the buyer to investigate the condition of the home, negotiate for repairs, ask for an extension of the closing date, or rescind their offer if the inspection turns up any major issues that weren’t disclosed. This is a very common contingency to include in an offer and one of the common reasons why the purchase contract is cancelled.
We recommend that a seller do a pre-listing home inspection to uncover any potential issues that they can remediate before listing their home and to also provide to prospective buyers as a way to market the home. While this contingency can eat into your net proceeds if you have to perform costly repairs, fully disclosing all issues with your home prior to accepting an offer will significantly lower the risk having to incur significant repair costs or risk having a contract cancelled.
Financing contingency
The financing contingency allows a buyer to cancel their offer if they do not receive final loan approval. By accepting this contingency as a seller, you run the risk of wasting time by taking your home off the market and having to relist it if the buyer can’t get financing. This can affect your net proceeds because if a home has to go back on the market, prospective buyers may think there is something wrong with the property. This could impact your negotiating power with future offers.
As a requirement as part of the purchase to help clear this hurdle, you can request a pre-approval letter and proof of funds from the buyer. You can also ask the buyer to cross-qualify with another lender in case their lender cannot perform. While these will help to mitigate the risk of the financing contingency killing the deal, it is not a guarantee. Things can come up or happen between pre-approval and final loan approval that can kill a deal.
Appraisal contingency
If the buyer of the home is financing the purchase, their lender will want to do an appraisal of the home to come up with the total value they are lending against. Lenders require that the home appraises for a minimum amount to validate the loan-to-value ratio and worse case assessing the risk of holding an asset that is worth less than the outstanding loan balance in the event of a buyer default. The appraisal contingency gives the buyer the option to cancel the contract or request the seller to lower the price of the home if the appraisal comes in low.
If a buyer waives the appraisal contingency, they are agreeing to cover the amount of the purchase price beyond what the lender will fund, rather than asking the seller to lower the price to the appraisal value. The buyer waiving this contingency does not provide a lot of value if the financing contingency is still in place.
Home sale contingency
In some cases the buyer won’t be able to purchase your home until they sell their home. This contingency is a way for a buyer to ensure they will have the proceeds from their existing home before they purchase yours. This can pose two potential problems. The buyer’s timing may not align with yours, and agreeing to this may mean handing control over the timeline to the buyer. Also, the buyer may not get the price for their home they currently own that they need and that could kill the deal for the purchase of your home. Carefully consider these types of purchases and set a timeline for the buyer so you are not stuck in a transaction that could end up being cancelled and you’ve lost out on other opportunities to sell your home.