Whether you’re buying or selling, you need to understand contingent real estate - what it is and how it works. Contingencies affect every real estate transaction and must be directly addressed before the deal can be finalized.
I’ll provide a quick overview of real estate contingencies in general, then discuss the details of the five real estate contingencies you’re most likely to come across in your future property deals.
Simply put, contingencies are conditions of a real estate transaction which must be met in order for the deal to close. Think of them as milestones to be passed on the way to finalizing the transaction. Each contingency will be assigned a deadline in the Contract to Buy and Sell. Contingencies may be accepted by formal acknowledgment, but acceptance is also assumed when no objection to a given contingency is noted prior to its deadline. Don’t worry if that sounds confusing; we’ll go over several specific examples together in this article.
Just remember: the contingencies listed in your Contract to Buy and Sell are conditions which must be met. If a contingency is not met, your deal cannot close! That’s why it’s so important to understand common types of real estate contingencies and the requirements of each.
Any number of contingencies can be written into a real estate contract (as every transaction is unique). But there are five types of common contingencies which apply to most real estate deals:
The main purpose of the title contingency is to confirm that the buyer will get “clear title” to the property upon close of escrow. Clear title just means that there are no other liens or claims against the ownership of the property. Buyers want to be assured when they purchase a home that no one else can approach them after the deal closes, claiming to own a share (or all!) of the property.
A title company will be hired to research the property’s title (the ownership rights). A good title company will confirm that the seller actually has the right to sell the property. So the title company is looking for any “clouds on title” (any items which could prevent the seller from having complete rights to sell the property).
They also research any issues which could prevent the buyer from “quiet enjoyment” of the property (legalese for living in peace on the property without interruption by claimants).
A title search and report by your title company typically includes the following:
The buyer needs to understand the status of the property’s title and agree to the covenants in the title report. If the buyer objects to any covenant, or if the title company discovers a cloud on title, the seller has the right to cure. Clouds on title are fairly common and often easily cured by the title company and the seller.
If the title issue can be cured, the contract is still enforceable, and the deal can proceed as planned.
In the unlikely event that the seller cannot cure the title issue, the property becomes “uninsurable” for the title company. This means a lender will not finance the purchase, and the property will be extremely difficult to resell. For this reason, the buyer of a home with an incurable cloud on title has the option to terminate the contract. In this case, the buyer would be entitled to a full return of their earnest money.
The purpose of a Homeowners’ Association (HOA) Contingency is to make sure buyers are aware of any HOA the property belongs to. HOA’s are private organizations which manage planned real estate developments. If your home is located in an HOA area, membership is mandatory; you cannot opt-out of an HOA, so you need to understand your HOA and its operations.
The HOA collects dues from all homeowners with property in the development to pay for maintenance of the development. This includes common areas like private streets and landscaping, as well as community amenities like pools, clubhouses, and security services. Some HOA fees may even include some utilities like sewer and trash.
Buyers must be aware of the amount of the HOA dues, which can range widely. Suburban developments without amenities may only charge $25 per month to fund private road maintenance. Urban condominium communities with full amenities like sauna, concierge, and fitness centers may charge over $1,000 each month! Many Colorado Springs area homes do not belong to HOA’s, but those that do typically pay between $200 and $300 per month in HOA dues.
HOA’s also require homeowners’ compliance with HOA bylaws. Buyers need to understand the conditions, covenants, and restrictions (CC&R’s) of the HOA. Some common CC&R’s include:
It’s important to understand the CC&R’s for your potential HOA because failure to comply could ultimately result in the HOA placing a lien against your home, which as discussed previously, could affect your ability to sell the home in the future.
Finally, buyers should research any special assessments levied by the HOA. Special assessments are a way to raise money for unexpected expenses. Well-managed HOA’s will reserve a portion of the dues for large projects, like a new roof or new road, in a reserve fund. However, the reserve may not cover the complete expense, and the HOA can levy a special assessment to collect the remainder from the homeowners.
Special assessments are also common in emergency situations like floods, fires, or tornados, where the insurance cannot cover the full cost of restoring the community.
Buyers have the opportunity to review all HOA documents, bylaws, and CC&R’s during escrow. If the buyer chooses to object to any terms of the HOA, they must do so before the HOA contingency deadline.
The purpose of the home inspection contingency is to allow buyers to inspect the property during escrow. And to make sure buyers are satisfied with the condition of the property prior to closing.
We recommend that every buyer take advantage of this opportunity by hiring a professional home inspector to physically inspect the property and report on its condition and any visible issues with the structure and systems.
You can research local home inspectors online to find an inspector, or you can ask your REALTOR® for a referral to a professional, certified inspector. If you are choosing an inspector on your own, make sure he or she is certified by ASHI (American Society of Home Inspectors) to ensure a quality home inspection.
It’s important to note that home inspectors can only inspect what is visible. They will not open walls or ceilings or dig below ground to search for additional potential issues.
A typical home inspection includes a physical evaluation of the following:
We recommend that buyers attend the inspection. This gives them a chance to get to know the property and to learn about the home directly from the home inspector. It’s also a great opportunity to ask questions of the inspector regarding the condition of the home.
Warning to buyers: your home inspection will report every little issue (or even potential issue!) uncovered by your inspector. Don’t panic! Many of these items are documented simply for the buyer’s information. They are the things we all live with like cracked sidewalks, staircases without handrails, or windows that stick when you open them. Take a deep breath before reviewing your inspection report, and know that not every item needs to be addressed. The inspector just wants to make sure you understand what you’re buying.
Some items may be serious and may require a remedy before the buyer is willing to release the inspection contingency and close the deal.
Some items may require an additional inspection. For example, if the home inspector notices electrical outages in the garage, they may recommend that a licensed electrician thoroughly inspect the electrical system.
Many items will simply be noted to bring them to the attention of the buyers and won’t require any action.
Your REALTOR® can help you navigate through the inspection, having seen dozens or even hundreds of them! Your REALTOR® can help you decide which items are serious, which items may need additional inspection, and which are just noted for your information.
Standard home inspections do not include:
But if you’re concerned about any of these potential issues, you have the option to hire specialists to assess and report on these specific items.
Once the inspection report has been reviewed by the buyer, their REALTOR® can draft the Inspection Objection. The Inspection Objection lists any items from the inspection that the buyer wants to be corrected before the deal closes. It’s also common for buyers to request a reduction to the agreed-upon purchase price so they can afford to correct the issue(s) themselves after closing, instead of asking the sellers to correct the issue.
Inspection Objections often start a whole new round of negotiations. Buyers typically expect the seller to cure some of the issues brought to light in the inspection report. And sellers counter the buyers’ request with an offer to cure some, but not all, of the issues noted in the original Inspection Objection. As with most negotiations, it’s best to enter the discussion with an attitude of compromise.
When the buyer and seller agree on the terms of the Inspection Objection, the inspection contingency can be released and the deal can proceed.
One quick note about the Inspection Objection Deadline: Time is of the essence with inspections and submitting Inspection Objections. To ensure a timely close of escrow, it’s in both parties’ best interest to leave time to negotiate the correction of any serious inspection-related issues. So there are deadlines listed in the Contract to Buy and Sell to keep the deal moving forward.
The Inspection Objection Deadline is especially important for buyers because failure to submit the Inspection Objection by the deadline could result in forfeiture of your earnest money, or even termination of your Contract to Buy and Sell.
Unless the buyer is making a full-cash purchase, they will need to secure financing to buy the home. And of course, the deal cannot close until the buyer is approved for the loan. The purpose of the finance contingency is to confirm that a lender has formally approved the buyer for the loan required to purchase the home.
“Pre-qualification” for a loan is not enough to release the finance contingency. Instead, the buyer must be “pre-approved”.
What’s the difference? Pre-qualification is a preliminary step to guide the buyer in their home search. Pre-qualification determines the types of loans, and potential loan amount, the buyer may be eligible for. This helps the buyer narrow their search to a more specific price-range based on what they can afford.
Pre-approval, on the other hand, requires the buyer to complete a full loan application so the lender can review the buyer’s complete credit history and financial situation, and commit to covering the loan. Learn more about prequalification vs. preapproval.
This loan commitment confirms that the buyer will be able to secure financing to complete the purchase as expected. If the buyer is unable to obtain a loan commitment from a lender, the deal cannot close, and the Contract to Buy and Sell is terminated.
Assuming the buyer is pre-approved for the loan, there’s still one last thing to consider before the finance contingency can be released: the Appraisal.
The appraisal is important to the lender because the property secures the loan. Consider the lender’s point of view: if the buyer fails to make their mortgage payments, the lender will foreclose on the property, and effectively become the new owner. So the lender needs to make sure the property is worth the price the buyer is paying.
And that’s what the appraisal does. It values the property during escrow to make sure the agreed-upon purchase price isn’t higher than the value of the property.
Once the loan has been approved and the appraisal accepted by the lender, the finance contingency can be removed and the deal can proceed.
The final walk-thru contingency is the last contingency to be released prior to closing. Immediately before closing, the buyer should physically walk through the property one last time.
During this visit, buyers should confirm that:
If each of these items is acceptable, buyers can release the final walk-thru contingency.
And your real estate transaction can successfully close!