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Real Estate Terms You Should Know: Contingent

Real Estate Terms You Should Know: Contingent

When a homebuyer makes a purchase offer, and the seller accepts, the home is considered under contract as long as certain “contingencies” are met that protect the buyer.

These contingencies allow enough time for the buyer and their lender to get the information they need to comfortably move forward with the transaction. If the contingencies aren’t or can’t be met, the buyer may be able to get out of the purchase contract or renegotiate the terms with the seller.

According to Homeward.com, typical contingencies include the following:

Home inspection – Buyers have a right to know what they’re buying and four out of five buyers insist on getting a professional independent third-party home inspection. A home inspection can reveal unknown problems and potential expenses that can impact the buyer negatively and possibly alter the buyer’s desire to complete the transaction.

Appraisal – A home’s contract price must meet the appraisal of value from the buyer’s lender. Like real estate professionals, appraisers use multiple listing service (MLS) data to generate a comparable market analysis of homes similar in location, size, age, condition and amenities to the subject home. They also look at tax records and conduct an in-person evaluation of the property to determine that the home is worth what the seller is asking for it. If the appraisal finds the home’s asking price is above the appraised amount, the lender won’t make the loan to the buyer. The seller may have to lower the price to complete the sale. If the seller refuses, they’re obligated to disclose the bank appraisal value to the next buyer.    

Mortgage approval – When a lender preapproves a loan to a buyer, that is just the beginning of the approval process. The lender does a cursory look at the buyer’s financial data to initiate the loan process, but the mortgage terms and the buyer’s ability to repay the loan must pass the lender’s underwriting standards. Underwriting is an in-depth look at the buyer’s finances, the appraisal, and other data to determine the lender’s exposure to risk. If something about the buyer is revealed in underwriting, such as an unsettled debt or unpaid lien, the lender can ask for proof of resolution from the buyer, raise the mortgage interest rate, or deny the loan.

Sale of the buyer’s current home – Many buyers have a home that must be sold before they can purchase another home. They either aren’t able to carry two mortgages and/or they need the proceeds from the home’s sale to complete the down payment to the seller. This introduces a level of uncertainty for both the buyer and the seller because the buyer’s home may take some time to sell, or it may not sell for as much money as the buyer hoped for, or it may not sell at all.

Title – The title company examines the property’s record of ownership and may discover an unknown problem such as an undisclosed lien, unpaid taxes on the property, or ownership dispute because of divorce, property boundary, or inheritance waiting for disposition by the probate court. While most problems can be resolved, delays or irreconcilable issues can occur.

It goes without saying that homebuyers and home sellers view contingencies differently. The buyer, of course, is making the biggest purchase of their lives on a home that may have unknown problems or that may not meet their lender’s approval. Their home may not sell as quickly as they’d like putting them at risk of carrying two mortgages. A contingency allows the buyer to get their earnest money returned if the purchase isn’t working out and move on to another property.

To the seller, a buyer’s contingency poses risks. At the least, the transaction’s closing may be delayed which could cost the seller money or put the home they want to buy in jeopardy. If the contingency isn’t met, the seller has to release the buyer from the contract, return their earnest money (a partial down payment designed to show good faith to the seller), and start the marketing process all over again to new buyers, who may be warier of making an offer on a home that’s just fallen out of escrow. For that reason, there are protections in place for the seller – the most important of which is that the home can still be marketed through the MLS by the listing agent but with terms like active kick out, contingent, pending or option.

Active means the listing is being actively marketed. Active kick out means that the seller has accepted an offer with a contingency, but reserves the right to “kick out” the first buyer if an acceptable back-up offer from a second buyer comes along.

A back-up offer means the second buyer knows they may not get the home, but they want it badly enough to wait and see if the first buyer is going to perform. If the seller accepts the back-up offer, they’re required to give the first buyer a notice to perform, which is typically 48 to 72 hours. The buyer then has the choice of removing or meeting the contingency and moving forward with the transaction or backing out of the contract.

A home that’s listed as pending can still be shown to back-up buyers, but it’s less likely to become available. A pending label means that the buyer’s contingencies have been met and that the seller and their listing agent believe the home sale will close escrow successfully. 

An option allows the buyer to purchase the right to the seller’s property when it may be a longer time than usual to closing. The difference between an option and an active kick out is that an option means the property can’t be sold to anyone else, nor can the price be raised for an agreed-upon term. Options are most often used to buy a new home from a builder, where there may be months until the home is built and ready for occupancy. When the home is ready to close, the option payment is used as part of the down payment. The builder is protected because the option payment is forfeited if the buyer doesn’t perform. Options are also used to buy raw land for development until the buyer can get funding and city and county approval for a proposed project.

A home listed contingent or pending is under contract, but there’s still a chance for other buyers to purchase the home. The listing agent will update the listing with showing instructions to other buyer’s agents, according to Rocketmortgage.com:

Contingent - continue to show (CCS):  the seller wants to pivot to a backup offer is the buyer can’t perform.

Contingent - no show:  the seller believes the buyer will have no problem removing the contingency.

Contingent - with kickout:  the buyer has a limited time to remove the contingency or risk the contract being voided.

Contingent – probate:  a deceased homeowner’s assets are going through the probate process, so the home may not be available for purchase for some time.

When a listing is pending, the contract is closer to closing, but there are exceptions:

Pending- taking backups: the seller is accepting backup offers in case the buyer can’t perform.

Pending- short sale: the mortgage holder has been asked to take less money than the seller owes on their mortgage.

Advice for homebuyers: In a hot market with low inventory, shopping contingent or pending homes could be a great way to make offers with less competition.

Advice for home sellers: If a contingency reveals a problem with the home, and the buyer backs out, the seller must update the seller’s disclosure to the next buyer. This is a document that outlines what the seller knows or doesn’t know about their property.

Article from BHHS.com