One of the most common concerns of buyers and sellers regarding the sale of real property (and in co-op stock sale contracts) is the addition of contingencies to contracts of sale. A contingency is a stipulation in a contract that must be met for the contract to become binding; it is a condition that must be satisfied if the deal is to be completed. It provides a party to the contract the right to back out of the deal, hopefully without being penalized. The circumstances under which this may occur are negotiated and are specified within the contract. Contingencies can be used to protect buyers and sellers.
It is almost axiomatic that, in order to induce sellers to sign contracts, successful buyers should try to demand as few contingencies as possible, especially in a seller’s market. And, a cash buyer is always preferable because he/she eliminates the need for a financing contingency and the time that it takes for the buyer to obtain mortgage approval.
Sellers in our area are most resistant to the house-sale contingency, and in my 27 years as a broker I have never participated in a deal that included this contingency. There are two types: a sale and settlement contingency and a settlement contingency. In a sale and settlement contingency, the buyer must sell and settle an existing home as a condition of the purchase of his/her new home. This contingency is used if the buyer has not yet received and accepted an offer to purchase his/her current property. The seller is permitted to continue to market his/her home even after the contract of sale is signed and the earnest money is received by the seller. If the seller then finds a more desirable buyer, then the seller may choose to protect him/herself and terminate the contract in order to sell to the new buyer by employing a kick-out clause if the original buyer cannot remove the contingency within a short time period (say, 72 hours). The original buyer can do this by proving that he/she has sufficient funds to buy the property even though his/her own property is not yet sold. A settlement contingency is used if the buyer is already in contract for his/her existing home and has a scheduled settlement date. Usually, the seller is prohibited from accepting other offers on his/her property for a specified period of time. If the buyer’s sale of his/her existing home falls through, then this contingency protects the buyer from the obligation to purchase the new property, there is no penalty to the buyer and the contract is terminated.
Thus, a house-sale contingency gives the buyer a specified time during which the buyer must sell his/her home in order to purchase the seller’s home. If the buyer’s house is not sold within this time period then the seller may cancel the contract or extend the time period.
Sellers—particularly those in hot markets where multiple bids are not uncommon—resist this contingency because they may be forced to decline another offer while awaiting the buyer’s sale. However, in a slow market, the seller may be willing to wait. Note that sellers who accept the house-sale contingency may be gambling, for as soon as the seller’s house enters into contract many multiple listing services require the listing to be changed from “active” to “in contract” or “pending.” This can discourage new prospective buyers from visiting and bidding on the seller’s house and, due to the change in listing status, the property may no longer even be advertised as available. But let’s say that a bona fide offer from a qualified buyer appears. The seller whose contract includes the house-sale contingency with permission to solicit new bids may invoke a right of first refusal provision: That is, the current buyer is given a short time period (say, 48 hours) to remove the contingency and proceed with the purchase or, if he/she is unable to do so, then the seller is free to accept the new buyer. If the original buyer chooses to remove the contingency and proceed, the seller may then demand proof that the original buyer has the funds to purchase. Because the seller does not want to lose the new buyer if the original buyer cannot produce funds, the seller will demand that proof of sufficient funds must be quickly produced in order to remove the contingency and proceed with the original sale.
I would caution any seller who considers accepting a house sale and settlement contingency to first ascertain that the buyer’s home is already listed for sale and that it is listed at the correct price. Ask your broker for comparable sales!
Buyers who use the house sale contingency should be aware that even if they can back out of the contract without penalty they do not do so without already having incurred certain costs such as fees for attorneys, bank appraisals, home inspections and termite and radon inspections. However, if they are successful in completing the purchase of their new home, then they have been given time to sell their current home and to buy their new home while avoiding paying for mortgages on two properties. However, some sellers may demand higher purchase prices due to the fact that the sellers are gambling on the buyers’ ability to sell their homes within a certain time frame.
Certain other contingencies are more commonly included in contracts:
Financing contingency (a.k.a. mortgage contingency): The buyer is given a specified time period during which he/she must obtain mortgage approval or request in writing an extension by the seller.
Appraisal contingency: The loan bank will typically conduct an appraisal and will also require certain documents such as a termite inspection certificate. If the appraisal does not support the purchase price then the lender will lend only the amount up to the appraised value minus the amount of earnest money already in escrow. Therefore, the buyer can choose to pay the difference between the appraised value and the purchase price or request that the seller lower the purchase price. If the seller will not do so or the buyer will not make up the difference then the contract can be cancelled. This contingency specifies a release date by which the buyer must notify the seller of any issues regarding the appraisal; if there is no notification then the contingency will be regarded as satisfied and the buyer cannot back out of the transaction.
Inspection contingency (also called due diligence contingency): The buyer has a specified number of days to perform a property inspection, do his/her own appraisal, obtain contractor bids, perform title research etc. If, for example, the home inspection discloses the need for newly discovered expensive repairs, then the buyer may choose to cancel the contract. However, the astute buyer can use the inspection report as a negotiating tool: He/she can ask the seller to make repairs or to reduce the price of the property by the amount that the repairs will cost. If some other problem arises—say, regarding something in the title report—the buyer may choose to give the seller the opportunity to cure the issue.
Homeowner’s insurance contingency: The buyer is required to secure homeowner’s insurance on the property. This is usually required by lending institutions and by some sellers. If a property is uninsurable then the mortgage lender will refuse to close the loan.
By Vivian J. Oleen
Vivian J. Oleen is an associate broker at Sopher Realty.