The Nuances of Real Estate Contingencies

A contingency in a real estate purchase contract is a way in which a buyer (or seller) could get out of the contract within a set period of time for a particular reason. For example, if there is a buyer contingency that the home must appraise to purchase price, but the appraisal comes in low, the buyer can get out of the agreement because of this - as long as the buyer has not already signed for the removal of that contingency. A seller might have a contingency that the sale of the home is contingent upon the seller finding a replacement property.

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Most home buyers and sellers in Silicon Valley understand that ordinarily, home purchases are contingent upon or "subject to" their approval of the property's condition and upon getting the desired loan. Under the broad umbrella of property condition and financing, though, there are other relevant or supporting issues, and consumers may not be aware of them.

For instance, with a loan or finance contingency, there are several key steps to go through in order to be assured that the lending institution will extend the loan as planned.

A pre-approval means that the buyer has turned in bank statements, pay stubs, copies of recent income tax forms, debt information, and so on - and all of it has been submitted to a lender (not just the person taking the loan application, who has conditionally approved it). With that approval, the lender then should require only a ratified purchase agreement, a preliminary title report, and a satisfactory appraisal.  Actually, though, there's a little more to it than that. What other issues could there be?

  • if loan rates change substantially and the buyer has not "locked" the loan, it may not be guaranteed
  • if there's a delay in the close of escrow (rain forcing a delay in fumigating the property, for instance) and the buyer's loan lock rate expires, the lender may not grant the loan
  • many lenders require an "outside appraisal review" and if it doesn't get through that step unscathed, the buyer may not get the loan
  • natural disasters such as fire or earthquake can cause lenders to pull the loan until the property is reinspected and/or reappraised

So buyers and sellers will want a little more information than simply "the buyer is preapproved". Here's what they need to know.

The Contingency Details

It's important to know if the loan rate is locked and for how long. Also it's imperative to understand if there will be an outside appraisal review, if it is delayed, what the lender will do about that (they can always take it to another company, but may be reluctant to do so). 

A few lenders may be discounting all appraisals by a set percentage - so that is another question to ask. Broadly, it is helpful to ask with the financing "what are the conditions?" and get a list from the lender. Hopefully, it is a short list!

Some sellers are having to part with their homes under a hardship and must attempt a short sale (in which the bank agrees to take less than is owed on the property). They have a seller's contingency that the offer's acceptance is contingent upon bank approval. When offers are written, a definite time period exists for that to happen - buyers may allow 3 or 4 weeks or more.

But what happens if the bank does not respond in time (which is often the case)? There's no sale and the buyers and sellers are "out of contract". If the bank later approves the short sale and the buyers agree to move forward, it may still lead to a closing. In most cases, though, the bank responds so slowly that the home is no longer worth what the buyer previously offered or worse, the bank never responds at all.

Property Condition

Similarly, with the property condition contingency, there are underlying issues besides just how the home does with the inspections. These supporting issues are key for Silicon Valley homebuyers to understand! In California, not only is the structure of the property and the land to be acceptable, but so do other related elements that may impact the buyer's sense of value for the property.

These may include things such as local school scores, the crime rate of the area, the presence of natural hazards such as being on an earthquake fault or being in a flood plain, the noise from local businesses or transit, and so on.

For homes belonging to a homeowner's association, it may also include the HOA documents with revelations about the financial stability of the association, the reserve account, neighborhood nuisances that are discovered by reading the newsletters and minutes of the meetings, etc. Having the house and yard in great condition does not mean that the buyer cannot find a reason to get out of the transaction based on the property condition contingency. The issues included are far broader than what is contained within the property lines.

Buyers should know that at some point, they will be selling.

You are not just buying a condo or a house - you are buying a neighborhood, with all that the area has to offer, good and bad. Visit it several different times on different days of the week to see how it looks and sounds. You don't want too many cars on the street, but of course if it's SuperBowl Sunday or Independence Day and it's just a party, there's probably nothing to worry about.

Do your due dilligence in person, online, and with the disclosures and reports. Ask questions and persue answers from the experts until you are satisfied that you truly understand the condition of the home and area. Don't sign blindly, even when the disclosures may look like boilerplate - make sure you understand what you are given so that you are not surprised about the property or area later.

Sellers should address area issues as well as those that come up in their home or yard.

Are there abandoned cars on your street? Do the roads have potholes? Is there a problem with the property line, a loud neighbor, or tree branches growing over a fence? Is tagging or graffitti an issue? Whatever annoys you as a homeowner is likely to annoy the buyer or prospective buyer of your home.  Best to do what you can to address and resolve these issues as the occur so that when you go to sell, you can disclose them as past issues and not ongoing nuisances.

An important mistake for sellers to avoid is making a late disclosure. If the buyer has removed all contingencies and the seller later provides a new, important disclosure, it may provide the buyer a new 3 day "right of recission" (a new opportunity to back out of the transaction). Do the disclosures early on and make sure the buyer receives them as soon as is practical so that there's not a chance that a new escape clause is inadvertantly given to the buyer. 

Buyers don't want this either - a new disclosure may come at a time that is too inopportune to back out (moving truck in the driveway, old home sold, or?) so they could be in a bad position of having to close escrow and then seek some sort of justice after closing. That would not be a happy event for buyer or seller.

For everyone involved in real estate transactions, there can be layers of issues to understand. Part of the challenge can be knowing which questions to ask.

With the loan or financing contingency, it seems to be a changing landscape due to the mortgage crisis, but asking the lender what hurdles still need to be cleared or what conditions exist is probably a good start.

With the property condition contingency, there are many sub-areas such as the title documents, the disclosures, the ability to get homeowner's insurance, and many other subjects. Because of the broad nature of that contingency, buyers do not have a difficult time getting out of a purchase agreement prior to the removal of the property condition contingency.

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