“Mom! Dad! I just bought a house!”
There’s nothing like the excitement of buying your first house – or for that matter, buying your second or third or fourth.
Mortgage pre-approval may have been difficult, the search was time-consuming, and the wait to find out if your offer was accepted seemed to take forever. But finally, it’s over – you’ve bought a house!
Um…not so fast.
Sure, both sides have signed the purchase and sale agreement. But that doesn’t mean that it’s a done deal. It usually takes longer than a month – often, closer to two – to move from the “accepted offer” stage to the closing.
And a lot can go wrong before you walk through that door as a new home owner.
The most-common reason that a home purchase falls apart before the closing can be summed up in one word: contingencies.
They can provide crucial protection for home buyers – but they can also be a double-edged sword. Because if your contingent offer falls through, that means you have to start the home buying process all over again.
How often does that happen? Not all that often, but often enough that you shouldn’t feel completely comfortable until the closing is over.
Home Buying Contingencies
If you’ve ever bought a house, you are probably very familiar with contingencies. They’re clauses in a contract that must be fulfilled before the sale can close.
Purchasing a house is the biggest financial deal most people will ever make. And the contingencies in a real estate contract essentially protect them if anything goes wrong, allowing them to kill the deal without suffering a life-altering financial setback. In most cases, all they’ll lose is the deposit of a few thousand dollars (the “earnest money”) that they paid the buyer when they signed the contract.
In a hot real estate market, with multiple bidders for every home that’s up for sale, sellers may be able to draw the line on contingency clauses. However, that’s only if they’re confident that someone else will make an offer without contingencies, in an effort to win a bidding war.
Frankly, that doesn’t happen all that often. Nearly all home purchase offers contain at least one contingency; most contain more than one.
Contingent offers don’t usually doom a home sale, though – far from it. In most years, only between 2-5% of home sales fall through because a contingent clause in the sales agreement couldn’t be met. (That number was up to 10% at the height of the original Covid pandemic, but has since returned to normal.)
What are the most common contingencies that buyers (or their agents) include in real estate contracts? And which ones are most likely to tank a deal? Read on.
Bottom Line: Contingency clauses are commonly written into a home sale contract. Sellers may only be able to “get away” without accepting them in a red-hot sellers’ market. However, very few home sales fall through each year due to contingent offers, so they’re usually just part of a normal real estate transaction.
Most Common Contingency Clauses
Nearly 95% of all home sale contracts include an inspection contingency clause – and that makes complete sense.
When you tour a home you’d like to buy, you’re obviously on the lookout for any major flaws. If the foundation is cracked, the roof is leaking or the gas stove is a fire hazard, you’re likely to pick up on those issues pretty quickly.
But what about the wiring? The plumbing? The insulation? You’re not going to be able to see those problems in the ten or twenty minutes you’ll spend in the house; you’re probably going to be more concerned about the home’s layout and where you would put the furniture. Only an expert can fully inspect a house and uncover potential issues lurking below the surface.
That’s why it’s almost a necessity to have a home inspection. Naturally, however, sellers won’t allow a potential buyer’s inspector into their home until the buyer has agreed to purchase it.
Thus, the inspection contingency. It gives the buyer the right to cancel the deal if there are major problems with the home – and the seller won’t remedy those problems to the buyer’s satisfaction. Inspections don’t usually kill a deal; in most cases, the parties agree to necessary repairs, or the seller lowers the final purchase price to cover the cost of fixing whatever’s not up to par.
The worst does happen at times, though. Approximately 15% of home sales fall through because of the inspection contingency. In many cases, it’s due to things that are extremely expensive to remediate: pest infestation, extensive mold problems or asbestos use, foundation issues, or a required roof replacement. Most other matters can be amicably settled between buyer and seller.
More than 85% of home buyers finance their purchase by taking out a mortgage loan. That’s understandable; the average price of a home in America is nearly $300,000, and very few people have that kind of cash to buy their home outright.
When you get a mortgage pre-approval, that allows you to shop for a house with confidence – but there’s no guarantee that the bank or mortgage company will give the loan final approval. That process only begins after a purchase-and-sale agreement has been signed.
So even though you’ve signed a contract promising the seller that you’ll buy their house, you can’t be certain that you’ll actually have the money for another week…or two…or three. What in the world will you do if you have to come up with $300,000, but the bank won’t give you most of the money you need?
That’s why financing contingencies are among the most common clauses in real estate contracts. If the seller agrees to this contingency, the buyer can walk away from the deal if they’re unable to obtain a mortgage.
About one-fifth of all failed home sales fall through for this reason.
Here’s another contingency that involves home loans.
Buyers and sellers usually negotiate before coming to terms on a home’s sale price. However, the bank or mortgage lender who – in most cases – will be providing most of the money for the deal wants a say as well.
Here’s why. Say you agree to buy a house for $250,000, and you’re going to come up with $12,500 as a 5% down payment. You’ll need your bank to loan you $237,500.
But what if the house is really only worth $225,000? The bank isn’t going to approve that loan; if you default on your mortgage and they repossess the home, they’re underwater financially. They own a home worth $225,000 but have already paid out $237,500. They’ll end up losing money – and banks aren’t in the business of losing money. (They also have a fiduciary responsibility to their shareholders to only make responsible loans, but that’s another story.)
The point is this: if an appraiser says a house is worth less than you’re paying for it, you won’t be able to get a mortgage. The best-case scenario is the seller agrees to lower the sales price to the appraised value; the second best case is that you find the extra money somewhere else. The worst-case scenario, of course, is that the seller insists that the sales agreement be fulfilled.
So once again, an offer contingent on home appraisal protects the buyer. If the home appraises too low, the buyer has the right to simply cancel the deal and walk away. Estimates vary on how often this causes an issue, but only about 5% of home sales fall through because of low appraisals.
Of course, financing and appraisal contingencies aren’t an issue if a buyer is paying cash.
Picture this scenario.
You’re selling your house and buying a new one. Maybe you’re upgrading, or maybe you’re moving to another city or state. Either way, you’re going to use the proceeds from the sale of your old house to pay for your new one.
You agree to sell the old house to a potential buyer, and agree to purchase a new one. But then – the sale of your old house falls through. You’ve already signed a contract for your new home, but now you won’t have the money to pay for it unless you can afford to pay two mortgages for a while.
You’re in trouble. That is, unless you’ve made your offer contingent on the sale of your old house. In that case, you can cancel your home purchase and walk away from the deal.
Sellers don’t like to put home sale contingencies in contracts, for obvious reasons; there’s way too much uncertainty involved. That’s why they’re only included in about 5% of purchase and sale agreements. In a down market, though, a motivated (or desperate) seller may agree to this type of contingent offer.
Bottom Line: Almost all home sale contracts include a home inspection contingency clause. Financing and appraisal contingencies are more common than not, and home sale clauses are rarely included. All can provide important protection for a buyer, however, when they’re making a purchase that may be the biggest they’ll ever make.
Contingent Offers: The Big Loophole
What if a buyer simply gets cold feet and wants to pull out of a sales agreement they’ve already signed?
It may not be a completely ethical approach, but some buyers use the contingencies in their offer to escape a deal they’ve decided to abandon.
The appraisal is a number. The financing is a yes-or-no decision. The home sale contingency isn’t commonly included. That makes home inspection clause the wild card.
Any home inspection will find some issues that need to be repaired or remediated. They may be small ones, or they may be large ones – but there’s nothing that legally prevents a buyer from simply refusing any repair or remediation offer the seller might make.
You can call it smart business, or you can call it slimy. But some buyers who have second thoughts about their purchase have found that using the inspection contingency is the easiest way to get out of a deal.
Bottom Line: Contingent offers can provide an escape hatch for buyers who change their mind after signing a contract. We’ll leave it up to you to resolve the ethical questions involved.
What Can Sellers Do To Protect Themselves?
Clearly, contingent offers protect the buyers and not the sellers. There are a few things that sellers can do, though, to protect their interests.
The easiest one is to simply refuse to accept contingent offers. As we’ve discussed, that may only be feasible in a hot sellers’ market, and it may limit the pool of potential buyers to those paying cash. Nevertheless, it’s one option.
The other option is to add a “kick-out” clause to a contract containing contingencies. This clause gives the seller the right to cancel the contract if another buyer makes a better offer. If the clause is invoked, the initial buyer has 48 or 72 hours to remove all contingencies and move ahead with the purchase – otherwise, the contract is null and void, and the seller is free to sell the home to someone else.
Bottom Line: Contingent offers place most of the risk on the seller’s shoulders, since only the buyer can cancel the deal. Buyers can protect themselves by refusing to agree to contingencies, or by including a kick-out clause that lets them take a better offer.
How Often Do Contingent Offers Fall Through: FAQ
Q: As a buyer, should I worry that including contingencies may keep me from getting the home I really want?
A: There’s that possibility, but if a sale falls through because of a contingency in the contract, it probably means that you’re better off without the house. For example, if the home is in such bad shape that you can’t agree on a resolution with the seller, you should consider yourself lucky that the contingency let you find the issues in time and bail out. Remember, contingent offers are meant to protect the buyer.
Q: As a seller, should I worry that including contingencies may keep me from selling my home?
A: Perhaps, but unless there’s such demand for your house that you can take a hard line and refuse contingent offers, you probably don’t have a choice. Almost all home sales with contingent clauses end up going through. Yours probably will, too.
Q: Is the inspection contingency really the one that matters?
A: Yes, if you’re paying cash for a house. Otherwise, the financing and appraisal contingencies also provide important protection in the event you find yourself without an approved loan and scrambling to put the deal back together.
Q: Is it OK for me to use contingencies to get out of a deal at the last minute, if I’ve found an even better house that I like even more?
A: Legally, there are no penalties for doing it. Morally? That’s up to you.