What Does No Contingency Mean In Real Estate?
A "no contingency purchase offer" is a commitment to buy a property as it is, without any way to rescind your offer. Exactly how a real estate sale will play out is normally quite uncertain. Every buyer, every seller, and every house is different. A home buyer will normally want to protect himself by adding contingencies to his purchase offer.
If a seller accepts your purchase offer to buy his home, the seller will likely demand you pay his for his losses if you do not complete the purchase. To protect yourself, you can make your purchase offer contingent (dependent) upon certain events taking place. If any of these events do not take place (the contingencies are not met), you can cancel your purchase offer and not create a failure on your part to follow the purchase agreement. You will not be held liable for any losses the seller has, if you meet the terms of the purchase contract and use a contingency to cancel the purchase.
Should I Write A No Contingency Purchase Offer
The real estate market is very competitive in Silicon Valley. A home will typically have multiple people interested in buying it and it will typically sell in a fairly short time. A seller is often planning to use the money from the sale of his home, to buy his new home, pay some expenses, or to invest. If you fail to complete the purchase, the seller will not be able to follow his own plans. If you offered a higher purchase price than anyone else, the seller will most likely be unable to sell it at that price again, and will have suffered a loss. Additionally the value of the home he is selling will generally change with time. If you do not complete the the accepted purchase offer, the seller could suffer a loss due to changes in the market place such as rising interest rates.
The seller compares your offer to other offers and to what he expects he will be offered. The seller will generally prefer a purchase offer that is more likely to result in the sale of his home. If you have contingencies that are vague or require a conditon that is less likely to be met, the seller may choose to accept an offer that pays him less money but is more certain to complete in the sale of his home.
There are a number of things that could prevent you from completing your purchase offer. Many home buyers depend upon getting a mortgage to pay for their purchase. There are many reasons why you may not be able to get a mortgage: interest rates could change, your credit report could reveal something negative, your income may not be judged sufficient to safely pay the mortgage, the home itself may be judged to be worth less than the mortgage, there may be environmental hazards that the lender judges as too risky, etc. If you do not have a mortgage contingency, you could be held liable for any loses the seller has if you are unable to purchase the home. Several common contingencies will be discussed below.
Contingency With Kick-Out Clause
If you make a contingent purchase offer, the seller may counter your offer and specify a kick-out clause. The seller will continue to market his home and may accept a backup offer. The seller can notify you that you have to remove your contingency and that you must perform to the purchase contract. If you do not remove your contingency, the seller can withdraw from the contract and proceed with a newer purchase offer.
Home Purchase Contingencies
Mortgage Contingency - Financing Contingency
A mortgage contingency allows the prospective home buyer a certain number of days to obtain a mortgage, typically at a specified interest rate. A buyer should be preapproved for a mortgage rather than simply prequalified. During the preapproval process the buyer will have already submitted much of the paperwork for a loan to be approved and will have been alerted to most problems with his qualifications. For the mortgage to be given, the home being purchased will also have to receive the approval of the lender. If the buyer is unable to get a mortgage after due diligence, the buyer can use his mortgage contingency to cancel his purchase.
Having no mortgage contingency provides evidence to the seller that you are well prepared to make the purchase offer and are commited to complete the purchase.
Before a lender will provide a mortgage for a home purchase, the lender will want to have an independent appraisal of the home's value. The risk a lender sees increases as the amount of money lended rises towards the appraised value. If the appraisal is too low, the lender will normally either provide a mortgage at a higher interest rate or provide a smaller mortgage loan. The buyer will have to provide more money to complete the purchase if the lender will only provide a smaller mortgage.
An appraisal contingency is generally more acceptable than a mortgage contingency to a seller because it only depends upon the home. It does not depend upon the unknown credit worthiness of the potential buyer.
A buyer can make a no appraisal contingency offer, with low risk, if they are quite certain of the value of the home and they have a way they can provide money to make up the difference between their purchase price and the appraised price for example sell stock, borrow money from his 401K, or borrow money from close relatives. A buyer should discuss the impact of his fall-back plans with his expected lender.
Home Inspection Contingency
In Silicon Valley, home sellers most often have a home inspection performed and provide the report to prospective buyers. Sometimes the report will call out issues that the inspector can not thoroughly inspect. Most lenders will want to see an inspection report before they will provide a mortgage. If either the seller does not provide an inspection report or the buyer is concerned about some issues, the potential buyer will generally add an inspection contingency to his purchase offer. The contingency will allow the buyer to have a certain number of days to have an inspection performed and review the report. The shorter the contingency period is, the more acceptable it will be to the seller. One to two weeks is a common contingency period.
After reviewing the inspection report the buyer can: remove his contingency and proceed with the purchase, cancel the purchase, or re-negotiate with the seller to get the issues resolved.
If a buyer makes a no inspection contingency purchase offer on an uninspected home, the buyer is accepting a significant risk that he will have to pay for repairs. One possible bad scenario is that the lender will identify a problem and require repairs before providing a purchase loan. Some of the things that inspection reports often call out are termite damage, dry rot, roof leaks, repairs not done to code, furnaces and appliances that do not operate correctly, lights and windows that do not operate correctly, cracks in foundations and cement, signs of plumbing leaks, and possible health hazards such as asbestos.
Inspection reports call out "section 1" and "section 2" problems. Section 1 problems are considered a potential safety hazard and will probably need to be repaired before a purchase loan will be provided. Section 2 problems don't necessarily need to be fixed immediately. They are often conditions that are likely to lead to "section 1" problems. Lenders will typically not require that section 2 problems be fixed.
A separate environmental report is also typically done which calls out health hazards such as toxic soil contamination, liquefaction risks, radon risks, asbestos risks, wildfire risks, etc. Wildfire risks have become very important.
Fire Insurance Contingency
For many years home buyers could fairly safely assume that they would be able to get property insurance on their new home. Huge losses to wildfires in California and regulations on insurance rates have prompted several large property insurers to stop providing property insurance in California. Lenders almost always require that property insurance be obtained and maintained in order for them to provide a purchase loan. If the home is located in a high wildfire risk area, insurance will be costly or even impossible to obtain.
If you are confident of your qualifications to get a mortgage, you might want to consider adding a fire insurance contingency instead of a mortgage contingency. This contingency does not depend upon your qualifications but only the property. It is likely to be more acceptable to a seller.
Flood Insurance Contingency
Although risk of flood damage is NOT insignificant for many Silicon Valley homes, a flood insurance contingency is extremely rare. Flood insurance is available from many insurance companies and from the National Flood Insurance Program (NFIP), which is managed by FEMA. Quoting the FEMA website: "Flood insurance is available to anyone living in one of the almost 23,000 participating NFIP communities."
The National Flood Insurance Act requires borrowers whose property is within a Special Flood Hazard Area (SFHA), to purchase flood insurance in order to receive a federally backed loan. A Special Flood Hazard Area is also know as a 100-year floodplain. Flood insurance rates are generally based upon Flood Insurance Rate Maps issued by FEMA. You can get estimates for the cost of obtaining flood insurance using the address of the property.
A point of confusion is that a "homeowners insurance policy" typically does not provide flood insurance, but is does provide fire insurance. Fire insurance is essentially always required to get a home purchase loan.
In Silicon Valley, title companies most often provide the escrow services for home sales. They also provide a preliminary title report and an offer of title insurance. The inspection report will identify any encombrances, attached judgements, or liens found. Lenders will generally want to have title insurance. If a title report has not been provided, a prospective buyer would normally add a title inspection contingency to his purchase offer.
It is rare that title problems cause losses for home buyers but a loss could be huge. Unfortunately schemes involving fraudulently selling real estate are becoming more widespread but usually involve vacant homes, vacation homes, or rental properties.
Common Interest Disclosure Contingency (HOA)
In Silicon Valley a home seller will normally obtain HOA documents for a common interest property and provide them to potential buyers. The HOA documents will disclose the financial aspects of the common interests, planned maintenance, restrictions on use (including renting out the property), and other important issues. A buyer can include an HOA contingency if either no documents were provided or more documentation is needed for any issues.
An often seen issue is that many common interest developments have rental restrictions. You can not safely assume that you can rent out your common interest property.
Lenders may see risk in certain common interest properties and not provide mortgages on them. Lenders often look at the percentage of properties that are renter occupied before loaning purchase money. A buyer should ask their prospective lenders about their willingness to provide a mortgage on the property.
Home Sale Contingency
A buyer will often need to sell a home he already owns in order to have the financial resources to purchase a new home. The buyer can add a home sale contingency to his purchase offer that allows him to cancel his purchase if he can not sell the home he already owns. This contingency significantly reduces the seller's confidence that the buyer will be able to buy his home. He would nearly always prefer an offer that does not have a home sale contingency.
The risk the contingency creates for the seller depends upon how much has already been done to sell the buyers' home. If the buyers' home is already in escrow, the risk might be considered quite acceptable. If the buyers' home has a pending purchase or contingent purchase, the risk could still be acceptable. The sellers' real estate agent will normally try to find out as much about the buyers' home sale as possible.
When there is a home sale contingency there are many events affecting the sale. The buyers' current home could potentially be sold to a different buyer who also wants to have a home sale contingency. Perhaps a seller does not want the sale of his home dependent upon a domino sequence of home sale contingencies and accepts the home sale contingency but adds that he has to approve the buyers' home sale.
Sale And Settlement Contingency
A sale and settlement contingency makes the buyer's purchase dependent upon accepting a purchase offer on his current home and closing the sale. The seller can continue marketing his home to other potential buyers with the stipulation that the first buyer will be given a specified period (typically 24-48 hours) to remove his sale and settlement contingency. If the seller receives another offer and the first buyer does not remove his contingency, the contract is terminated, the seller can accept the second offer, and the first buyer's earnest money deposit is returned to the buyer.
If a buyer has already accepted a purchase offer on his current home, has a signed contract and a scheduled closing date, the buyer can include a settlement contingency in his purchase offer. If the buyer's home closes escrow by the specified date, the contract remains valid. If the home does not close, the contract for the buyer's new purchase can be terminated.
A backup offer is an offer that is made knowing that there is already an accepted offer. It is a legally binding contract with the seller (if it is accepted), that if the previous purchase offer(s) do not close escrow then the contract for the backup offer is valid and enforceable.
Contingencies reduce the risk of a purchase but you should always perform your own due diligence. Only you can weigh the risks, and decide if they are low enough that you choose to not include a contingency in your purchase offer. It is easy to miss the cost of potential problems or to make false assumptions. Inspection reports identify many problems but also call out things that can not be inspected. They are a great assistance to performing your own due diligence and evaluating risks. Only you can evaluate the risk of your own financial strengths and weaknesses with the aid of an experienced lender.
The cost of purchasing a home makes most buyers worried about mistakes. Even if a contingency saves you from suffering a loss, the emotional toll should be avoided. Your own due diligence avoids much of the worry and emotional toll. Your purchase will be more enjoyable for even years ahead if you decided an issue was acceptable rather than it surprises you.
When To Include A Contingency
Every real estate sale is different. Even with experience, risks can not be assigned a simple value. If you ignore the risks you may suffer large losses. If you try to include a contingency for every possible event, you may not be able to find a seller who will sell you his home. An experienced real estate agent can help you prepare back-up plans, can make your contingencies more acceptable to a seller, and can alert you to issues you may not have thought about. You should have a thoughtful, detailed, discussion with your agent so that you can make a successful purchase offer that does not create unnecessary risks for you.
Generally, contingencies are added to a purchase contract by the buyer. However there are times when the seller adds contingencies.
If the sale is being done due to the death of the owner, the sale may be contingent upon the approval of all of the former owner's trustees. There may also be a right of first refusal that gives an opportunityfor a close relative to purchase the home.
If a homeowner can no longer pay his mortgage and the value of his home has dropped, he may get his lender to allow a short sale. A short sale is the sale of a home where the home is sold for less than the existing mortgage amount. The sellers must have a contingency for bank approval. If the lender does not approve of the sale, the seller does not have to sell the house to the buyer. The listing on the MLS must include that the expected home sale will be a short sale.
Many home sellers are planning on buying a new home. The sellers may have a contingency that the sale is subject to the sellers finding a replacement property. A time period will be specified. This contingency must be listed on the MLS. Just as sellers want to be confident the sale will close, buyers want to know their purchase will succeed. This contingency will reduce the expected sales price of the home.
A seller may specify that they have the right to rent back the property from the buyer for a specified period after escrow closes. Generally the buyers' lender will limit how long the rent-back can last and still have the property qualified for an owner-occupied mortgage. The rent-back period provides a margin of time for the seller to complete the purchase of his new home and move out of the home he is selling.