The word ‘contingency’ is probably the most important terminology in a real estate transaction, which, most buyers and sellers fail to understand. Maybe, as a result of the lack of education from real estate agents who represent them, or, simply not asking their agents to further elaborate and explain what contingencies really mean.
For the purpose of this blog, I refer to the common contingencies in a residential real estate transaction in the state of California.
So, what is a contingency and removal of contingency? Why do we need to understand them? What is the effect of this contingency on my real estate transaction, if I were a seller or a buyer?
According to the California Association of Realtors’ legal definition, a contingency provides a buyer or a seller the ability to condition performance (closing escrow/funding the loan) on the occurrence or non-occurrence of another event. A buyer, for example, can condition that a home inspection be performed & be satisfied with the findings of the professional home inspector. If buyer elects to proceed despite future or immediate repairs on the property, he then, removes the contingency on home inspection. By doing so, the buyer is telling the seller that ‘ I am no longer making the home inspection an issue, I am removing it my from list and sale is no longer contingent on home inspection. Let’s then move on.’ And so forth.
Aside from the home inspection contingency, here are some of the most common contingencies found in the California purchase contract, which a buyer must be aware of:
1. Appraisal Contingency – contained in Paragraph 31 of the Residential Purchase Contract. Though different and separate from the loan contingency, the appraisal contingency is tied to the results of the loan underwriting ( there are cases when a lender is willing to lend against a property for more than the appraised value). A buyer need not go through the transaction if the property appraises for less than the contracted price and buyer’s lender is not providing the full loan amount. If closing the transaction would mean buyer having to come up with the difference ( appraised value vs contracted price), this appraisal contingency provides the buyer ability to cancel or renegotiate the contract price to reflect the appraised value of the subject property.
2. Loan Contingency- if buyer is going thru financing, Paragraph 3 needs attention/help from the real estate agent. I have seen countless offers, in which this section left undone. It is important to disclose the type of financing the buyer is going for, the maximum interest rate buyer is willing to get, and maximum points he is willing to pay for, in exchange of that rate. If within the contingency period, the buyer does not get this specific loan disclosed ( e.g. rate does not exceed, 4.5%, with no more than 1 point), buyer can cancel the contract and not be in breach of contract.
3. Home Inspection – the default/standard time to remove the inspection contingency is 17 days, though this maybe changed, per mutual agreement. Buyer has the right to conduct physical inspection of the property and should either accept the condition of the property as is, negotiate for repairs with the seller, or cancel the contract within the agreed investigation period.
4. HOA Disclosures/Seller Disclosures - in the case of condominiums/townhouses where HOA rules govern the use of the property, the buyer should be provided documentation pertaining to rules & regulations of the HOA ( commonly called as CC&Rs). same with seller disclosures, some of which are the Transfer Disclosure Statement, Seller Property Questionnaire, Natural Hazard Disclosure Statement.
5. Short Sales Lender Approval - The Short Sale Addendum is usually submitted by the buyer purchasing a property that will be subject to the seller’s lender’s approval. If, by the specified date in the SSA, seller still has not received approval of the buyer’s offer, buyer may cancel the contract.
A seller, on the other hand, can have a Contingency For Sale of Other Property, meaning, the purchase of a new property is contingent upon the successful closing/sale of seller’s current property.
Unless a contingency is removed, the contingency remains a contingency and buyer has the opportunity to cancel the contract. If, by end of the contingency period, buyer does not remove contingencies in writing, seller may issue a Notice to Buyer to Perform. If, after notification, and buyer still has not performed, seller may cancel the contract and not be in breach.
Once a contingency is removed, buyer and seller must close escrow. If one of the parties is delaying the close of escrow, the delaying party can be served a Demand To Close Escrow. If, after the notification, the delaying party does not perform, the aggrieved party must consult an attorney for possible remedies such as suing for specific performance.
In the event that buyer defaults and fails to close escrow, Seller has the right to retain the deposit paid, as liquidated damages. No more than 3% of the purchase price, though, is retained, and any excess is returned to the buyer.
It is very important to pay close attention to dates of acceptance, opening of escrow etc, as the clock ticks immediately and the buyer has a limited window to fulfill all contractual obligations. Prior to purchasing a property, it is a good idea to line up qualified vendors – a licensed home inspector, termite inspector, and of course, a mortgage broker or loan officer who will do loan your pre-qualification. Your real estate agent is a good resource person for referrals, if you do not know one.
