Real estate is more than just about selling and buying. It’s also about signing and copying. You may or may not enjoy doing the “backend” paperwork. But it’s just as important as all the other work involved when it comes to buying and selling real estate.
Which brings us to contingency clauses. Contingency clauses are some of the most important parts of a real estate purchase contract, and can provide significant protections to buyers of real estate.
Whether you’re buying or selling real estate, it’s essential that you know how to use contingency clauses to your advantage.
Contingency Clauses 101
Let’s say you want to buy some real estate. A contingency clause often states that your offer to buy property is contingent upon X,Y, & Z. For example, the contingency clause may state, “The buyer’s obligation to purchase the real property is contingent upon the property appraising for a price at or above the contract purchase price.”
Under this contingency, you’re relieved from the obligation to buy the property if the you obtains an appraisal that falls below the purchase price. Because contingency clauses provide you with a way to back out of a contract, they can be great tools for real estate investors who make offers on properties.
Common Contingency Clause Examples
Here are three contingency clauses to consider in your real estate purchase contract.
- Appraised Contingency: An appraisal contingency protects buyers of real estate and is used to guarantee that a property is valued at a specific amount. If the appraisal comes in lower than the amount, the contract can be terminated. Another perk to this contingency is that you’ll probably get your earnest money back as well.
- Financing Contingency: A financing contingency will usually, “Buyer’s obligation to purchase the property is contingent upon Buyer obtaining financing to purchase the property on terms acceptable to Buyer in Buyer’s sole opinion.”
Some financing contingency clauses are not well drafted and will provide clauses that say simply, “Buyer’s obligation to purchase the property is contingent upon the Buyer obtaining financing.”
A clause such as this can cause problems as the Buyer may obtain financing under a high rate and may decide not to purchase the property. However, because the contingency only specified whether financing is obtained or not (and not whether the terms are acceptable to buyer), the clause can be unhelpful to a buyer deciding not to purchase the property.
Some financing clauses are more specific and will say that the financing to be obtained must be at a rate of no more than 7% on a 30 year term. They’ll add that if the buyer does not obtain financing at a rate of 7% or lower then the buyer may exercise the contingency and back out of the contract.
- Inspection Contingency: An inspection contingency clause might state, “Buyer’s obligation to purchase is contingent upon Buyer’s inspection and approval of the condition of the property.”
Another variation states that the Buyer may hire a home inspector to inspect the property and that the Seller must fix any issues found by the inspector. If the Seller does not fix the items specified by the inspector then the Buyer may cancel the contract. Inspection clauses help guarantee that the Buyer is obtaining a valuable asset and not a money pit.
Details to Watch for in Contingency Clause Fine Print
The devil of contingency clauses is in the details, which of course, often come in small print.Due to the nature of contingency clauses, you want to make sure you pay attention to certain key terms and phrases. All it takes is one sentence to either win or lose you a dispute over one of the following issues.
- What happens to my Earnest Money? One thing that’s usually vague in real estate purchase contracts when it shouldn’t be is what happens to the buyer’s earnest money when the buyer exercises a contingency.
Does the buyer receive a full return of the earnest money? Does the seller keep the earnest money? If the contract is silent and if you as the buyer exercise a contingency, don’t bet on getting your money back. It’s likely you’d lose even more money!
Make sure your contract clearly states something like, “If Buyer exercises any contingency, Buyer shall receive a full return of any earnest money deposit or payment to Seller.”
- Contingency Deadlines. You don’t want to miss one of those! Most contingency clauses have deadlines well before closing. Those dates being typically somewhere from 2 weeks to 2 months from the date of the contract, depending on the purchase and seller disclosure items and the type of property being purchased.
For example, single family homes will typically have a shorter window as financing and inspection can occur more quickly than would occur under a contract to purchase an apartment building.
Whatever the deadline is, make sure that the deadline is set so that you can complete your contingency tasks. You need to make sure you have enough time to obtain adequate financing commitments, to properly inspect the property, and that you have enough time to review the seller’s disclosure documents.
Setting a two week deadline is sometimes done. But two weeks is usually not enough time to complete financing commitments, inspection, and due diligence activities. All of which are necessary to determine whether you will or won’t purchase a property.
If contingency deadlines are fast approaching and you need more time, then ask the seller for an extension before the deadline arrives. If your Seller refuses an extension, point to your contingency and tell them to read it and weep.
- Exercise your contingency in writing. Yes, even in the digital age, the pen and paper still go a long way as far as contracts are concerned. If you do exercise a contingency and decide to back out of the purchase of the property, make sure you do it in writing.
Don’t bank on telephone calls or even emails (unless the contract permits emails as notice). Make sure that the reason for the contingency and that the date of the contingency are put in writing and are sent to the seller in a method where the date can be tracked.
For example, if your contract requires a contingency to be noticed by fax or hand delivery, don’t rely on an email to your seller or your seller’s agent. That won’t invoke the contingency, and you may end up unhappy to say the least.
The Importance of Contingencies for Real Estate Investors
Let’s say you’re the buyer again. Once the deadline to exercise a contingency has passed, you’re obligated to purchase the property and may be forced to buy the property. Or at the least you will lose your entire earnest money deposit.
Contingency clauses are your best defense to a bad deal and should always be used by real estate buyers. Hopefully by now you’ve realized that your purchase contracts are only as good as the contingency clauses behind them.
If these kind of details make your head spin, don’t worry. That’s what us real estate attorneys are here for. Schedule your consultation now to never fall victim to the “fine print” again.