Contract Contingencies: Buyer Protections vs Market Realities
When buyers and sellers negotiate a real estate purchase, they don’t only negotiate the price—there are also contingencies to be negotiated. Contingencies are conditions that must be met in order to proceed with the contract. If a contingency is not met, one of the parties may be able to terminate the agreement, and the contingency will detail the fate of the earnest money. The most common contingencies typically benefit a home buyer. Here, we’ll look at four of them.
Due Diligence or Inspection Contingency: This contingency gives the buyer a period of time to inspect the property. It’s essentially a free-look period during which the buyer can terminate the agreement for any reason or no reason. The duration of the period is negotiable, as the buyer typically wants more time while the seller wants less. During that period, the buyer can hire a qualified home inspector (it’s best not to rely solely on the lender-required appraisal, which only provides an estimate for loan purposes and does not analyze the structural integrity and health of the home’s mechanical systems). Buyers can also consider a termite inspection (in Georgia, it’s not if a house gets termites, it’s when), as well as a septic tank or well inspection if the property includes these features.
These inspections take time to coordinate, so buyers need to allow enough time in the contract to schedule them—often 10 to 14 days is acceptable, but it depends on the extent of the anticipated inspections. If the inspection finds a problem with the home, then the buyer can ask for repairs or a lower price.
Financing Contingency: With this contingency, the offer is contingent upon the buyer obtaining financing subject to particular terms, including the type of loan, loan amount, interest rate and maturity. If a buyer is denied a loan subject to these terms, the buyer may terminate the contract and receive any earnest money deposited. Be aware of any expiration date; if the loan is denied after the contingency expires, the buyer may well lose their earnest money.
Appraisal Contingency: An appraisal contingency requires that the home appraise for at least as much as the purchase price. If the appraisal comes in low, the buyer can terminate the contract and receive their earnest money back. Historically, the failure of a home to appraise has only been an issue in declining markets where home prices are dropping. These days, many areas of Georgia are seeing tremendous increases in home prices—which actually brings its own appraisal issues. Home prices are being bid up quicker than increases in appraised values, meaning that a lender may refuse to make the loan. What’s more, appraisal contingencies are usually subject to an expiration period just like financing contingencies, and the buyer should make sure the appraisal is complete before the contingency expires.
Sale of the Buyer’s Property: With this contingency, the buyer seeks to have the purchase of the new home contingent on selling their current home. If the buyer doesn’t close on the sale of their current home by a particular date, the buyer can terminate the contract and receive their earnest money back. Of course, sellers disfavor this contingency, and in a competitive market may reject offers that include it. And if a seller does accept a contract with this contingency, the seller may require a kick-out provision to allow the property to continue to be marketed. Then, if the seller receives another offer, they must notify the buyer, at which time the buyer can either remove all contingencies and proceed to closing or terminate the contract and receive their earnest money back.
Whether to include any of these contingencies is all part of the contract negotiating process. Sellers prefer fewer contingencies, while buyers want the protections that contingencies provide. A licensed real estate agent or local attorney can help a buyer draft a competitive offer that balances a buyer’s desire for protections with market realities. Once the contact is agreed on, then be sure to note any expiration dates on the calendar so there aren’t any surprises.
William Phalen is a partner with the firm of Sherman & Phalen, LLC. For more than 20 years, Sherman & Phalen, LLC, has conducted residential and commercial real estate closings in Georgia, Florida and South Carolina. Phalen is the past president of the Georgia Real Estate Closing Attorneys Association and is on the Executive Board of the State Bar of Georgia’s Real Property Law Section. As a board member of both organizations, he has worked on legislative matters that include defining and policing the unauthorized practice of law when performing real estate transactions, the licensing of attorneys with the insurance commissioner’s office and the manner of issuing liens for unpaid water bills, among others.