Real Estate Contingencies: What They Mean, Rules, And How To Use Them

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In real estate transactions, a contingency clause can be put into a contract so that either the buyer or the seller can walk away from the deal if certain things happen – the contingencies. A real estate agent can help their clients understand contingencies and whether they’re necessary for the deal they want to make. Laws regarding contingencies and their rules vary by state, so it’s important to gather all the information you need on what these are so you know how to use them to your advantage.

Including contingencies in your real estate contracts can provide you with a safety net. You can make sure the deal will work out according to your specifications so that you benefit the most. And if anything doesn’t seem right, you can walk away. Here’s more about what contingent means in real estate and how you can use contingencies as a real estate investor.

What Does Contingent Mean in Real Estate?

A contingency in real estate is a statement (a “stipulation” it’s sometimes called) that is added to your contract that will allow you the right to back out of the deal without penalty under specific circumstances. Contingencies are often used by buyers who aren’t 100% convinced they’re ready—or able—to purchase the property. It gives them extra time to “get their ducks in a row.” And if they can’t do what’s necessary to close the deal, they can walk away.

What Is the Difference Between Pending and Contingent?

When searching for a property to buy, you may have seen a listing that says “pending” or one that states “contingent.” These are common terms in real estate, and if you know what they mean, you can take advantage of potential deals.

A pending sale is one that is in its final stages. The only tasks left to complete are the final paperwork and closing. Once these are done, the sale is final and the new owner takes possession of the property. No other buyers can make a deal on a home sale that’s pending. While deals this far into the process don’t often have issues, it can happen. If you’re ready, you may be able to swoop in and find a motivated seller.

Contingent sales, however, are those that have a condition that must be met before the sale is finalized. For example, there might be a mortgage contingency that bases the deal on whether the buyer can obtain financing for the property. Although a seller can’t officially accept any offers when a property is contingent, you can submit offers as a backup just in case the deal falls through. Most contingent deals go through, but during this stage, the process is still quite vulnerable. Making backup offers on contingent properties can set you up to be next in line for a great deal.

How Do Contingencies Work?

Contingencies give buyers, and sometimes sellers, the chance to back out of a real estate deal without a penalty, such as losing your earnest money deposit, if something isn’t right. Writing contingency clauses into your real estate contracts gives you the chance to terminate the contract for a variety of reasons. As an investor, especially a new investor, it’s important to get the best deal possible when buying properties. Using contingencies provides protection to the buyer because they won’t be forced to buy a home they can’t afford or one that needs extensive repairs that aren’t readily apparent.

When you’re ready to make an offer on a home, discuss contingencies in your contract with your real estate agent. They can guide you on which ones to include and make sure you understand what each contingency means for you. Your agent can write up the contract with the contingencies for you and the seller to sign. Then if any of the contingencies aren’t met by the dates specified in the contract, you can walk away from the deal.

Make sure you understand the deadlines associated with your contingencies, as they can be a loophole that ties you to the deal. For instance, you might need to notify the seller that you want to back out of the deal due to a failed home inspection within a week of the inspection date. If you wait even 10 days, you could miss your chance to get out of the deal without any penalties.

Some sellers might not want to work with you if you have too many contingencies in your contract. If you’re not sure you want to buy the property, they may pass up your offer for something more enticing and with fewer or no contingencies. Use contingencies to your advantage, but know their limitations.

What Are the Most Common Types of Contingencies in Real Estate Contracts?

Let’s review the most common types of contingencies you’ll find in a real estate purchase offer:

Financing contingency

This is one of the most common types of contingency. Basically, it says that your offer is contingent on you being able to procure financing for the property. It will often be specific about the type of financing, such as an FHA loan, conventional loan, or private money lender, the terms, including the interest rate and down payment, and the time period, typically 15 or 30 years.

For example, a typical financing contingency might read as follows:

Buyer shall have 20 days from the date of binding agreement (“Financing Contingency Period”) to determine if buyer has the ability to obtain a loan with the following terms:

• Loan amount: 96.5% of the total purchase price of the property.
• Term: 30 years.
• Interest rate: No higher than 7.25%.
• Loan type: FHA.

This agreement shall terminate without penalty to the buyer if the buyer is unable to obtain the loan described above and notifies the seller in writing of this event within the Financing Contingency Period.

Any buyer who is planning to use financing to purchase a property should include a Financing Contingency; worst case, your financing will fall through, but you’ll still have the option to back out of the deal without penalty.

Appraisal contingency

This contingency basically says:

• If you can’t get an appraisal on the property that is at least as high as the purchase price, you can back out of the deal.
• If you can’t get an appraisal on the property that is at least as high as the purchase price, you can ask the seller to drop the price, and if they refuse, you can then back out of the deal.

The appraisal contingency often goes hand in hand with the financing contingency, as the lender will not fund the loan above the appraised price.

Inspection contingency

Also known as a “Due Diligence Period” or a “Due Diligence Contingency,” this contingency says that the buyer has a set amount of time – often ranging from three to  14 days – where they can do whatever they need to do to ensure they want to buy the property. This might include inspections, appraisals, contractor walk-throughs, and more.

If at any time within that inspection period the buyer chooses to back out of the deal for any reason, they can. This is a common contingency for anyone who is not intimately familiar with inspecting properties and coming up with rehab cost estimates. The buyer can use this time period to get a full property inspection and get bids from contractors to do any necessary work. If any surprises turn up, they can then either ask for a discount (or repairs) or just back out of the deal.

Selling a current property

This one has become more prominent these days among homeowners looking to upgrade their current house. This contingency basically says that the buyer has a right to back out of the deal if he can’t sell his current residence to someone else. Generally, the contingency will call out a time period for which the contract is in effect, thereby giving the buyer that amount of time to sell their other property.

This contingency is not generally used by investors but is very common among homeowners going from one house to another.

While there are literally thousands of other possible contingencies that you might see or use in a real estate contract, these are the most common, and many of the others are based on one of these.

Additional contingencies you may encounter

You may also come across these contingencies in your real estate contracts:

• Termite letter contingency.
• Lead paint test contingency.
• Deed contingency (stipulates what type of deed is expected from the seller at closing).
• Radon testing contingency.
• Mold inspection contingency.
• Sewer inspection contingency.
• Private well inspection contingency.
• Homeowner association documents contingency.
• Insurance contingency.

Common Contingency Statuses

There are different statuses that come with making contingencies that can be added to a real estate contract. They each have their own slight variation, and we’ve laid it out for you here to provide you with a basic understanding of what the most common contingency statuses are:

Kick-out

A seller might want to add a kick-out clause to your contingency. If they do, it allows them to look at other offers while they wait for the contingency in question to clear up. They might consider higher offers or those with fewer contingencies. Sellers can’t just pass you up because a better offer comes along. Just like with your contingencies, a seller has to give the buyer time to remove the contingencies before they can walk away from the deal. If you don’t meet their deadline, then they can terminate the contract, kicking you out of the deal.

No kick-out

If a seller doesn’t add a kick-out clause, they can take their time to clear up any contingencies. They won’t be able to look at other offers while they wait, though, and most sellers want to move things along so they can sell their house.

Short sale

A property that has a short sale status means that the seller is willing to take less for the property than is owed on the mortgage. Banks often do this if they need to purge the asset but don’t want to deal with foreclosure. When a property is short sale contingent, it means that the seller has accepted an offer. The property is still in the process of the short sale.

Contingent probate

Properties go into probate when an owner passes away and there are questions about who now owns the property. If a property is contingent on probate, it means that it’s being sold because the owner died and the court likely ordered the sale. The property or the buyer may have to meet certain requirements that adhere to any judgments on the property.

4 Rules for Using Contingencies

Now that you hopefully have a good idea of what contract contingencies are, let’s look at the four rules for using contingencies (or not) to improve your investing success:

Rule 1: The fewer contingencies in your offer, the more attractive it is to the seller

The seller wants to sell their property as quickly and as efficiently as possible, and any contingencies you put in your offer are an opportunity for you to back out of the deal before it closes.

So, as a buyer, you want to limit your contingencies to only those that are absolutely necessary. Sometimes contingencies are very important but don’t use them more than necessary to protect your interests. And, if you have the ability to use no contingencies in your offer, it makes it much stronger than any competing offers.

Of course, unless you have had the property inspected (or have done it yourself) and are absolutely sure that you want to move forward, you take a risk by not having a contingency in your offer. So use them accordingly but also sparingly.

Rule 2: If possible, limit your offer to a single contingency

While it may be more reassuring to you to have lots of contingencies in your offer – it means you have more leeway to change your mind, right – the truth is, a single contingency often provides all the protection you need. In fact, the only contingency used in about 80% of investor deals is the inspection contingency.

The inspection contingency will give you a fixed period of time – generally five to 10 days, depending on how much you need – to get everything in order to ensure you want to – and can – buy the property. During that inspection period, you will get a property inspection completed, ensure you have financing lined up, create your scope of work, have contractors come to the property to give you bids, and contact an insurance agent to get quotes.

After the inspection period is complete, you should know whether you’re ready to move forward on the property. If you’ve come across anything concerning, like structural issues, mold, missed repair costs, or anything else, you might go back to the seller to request a lower price and worst case, you might have to back out of the deal.

Rule 3: Only execute a contingency if absolutely necessary

Many investors will make lots and lots of offers, each with contingencies. They won’t even bother looking at properties unless they get their contract accepted. While this is a perfectly reasonable way to make lots of offers in a short period of time, it also increases the probability that you’ll end up having to back out of one or more of those offers using your contingency.

Perhaps you find that there is more repair work than you thought. Or maybe you find that there are structural issues that will be costly to fix. Or maybe you determine the layout of the property will make it difficult to sell. Regardless, if you’re not careful, you’ll find yourself backing out of deals with your contingencies.

And if you back out of too many deals, you run the risk of getting a bad reputation. If you work with the same listing agents over and over and you have a reputation for backing out of deals using your contingencies, you’ll find that you start getting fewer offers accepted. Remember, sellers are interested in getting rid of their properties as quickly and efficiently as possible, and if they think you’re just going to waste their time by backing out of the deal, they won’t even bother to accept your offers.

Rule 4: Contingencies can be negotiating tools

Just because you find that the deal isn’t working out for you doesn’t mean that you need to use your contingency to back out. You can use that contingency to reopen negotiations with the seller instead.

For example, let’s say that during your inspection you find there are some major plumbing issues in the property that will require an extra $3,000 in plumbing work that you hadn’t factored into your budget.

Instead of using your contingency to back out of the deal, use it as an opportunity to ask the seller to drop the price by $3,000. Not only do you keep the deal alive, but the seller would likely face the same issue with the next buyer. So one way or the other, they’re going to end up eating that $3,000 cost.

Or, let’s say your financing falls through – instead of using the contingency to back out of the deal, perhaps you can use it to reopen negotiations around seller financing, especially if the seller is a bank.

The key is that even when you use a contingency, you don’t have to use it to back out of the deal; you can instead use it to revisit the original deal and try to come to a reasonable compromise that resolves the issue(s) and makes both parties happy.

Do Contingencies Protect Buyers or Sellers? 

A contingency protects the buyer for the most part, but the seller can benefit from contingencies as well in some cases. Buyers benefit because they can back out of the deal based on certain conditions as long as they meet the guidelines in the contract. If they can’t get financing or if they can’t sell their home, for example, the buyer could back out of the deal.

Sellers can put limitations on how long a buyer can take to remove contingencies, which gives them some protection from extending the deal too long. Having a home inspection contingency is recommended because there can be issues, like mold or water damage, that may not be apparent to the buyer. This contingency can help you save thousands in unexpected repair costs.

Can you make an offer on a contingent property?

Sometimes sellers will look at offers on contingent properties. However, they can’t accept any offers while the property is under contract. They may decide on a backup offer they like and keep it in reserve in case anything falls through with the sale.

Can a seller accept another offer while contingent?

A seller has to honor the first offer they accept. Therefore, they can’t accept any new offers unless something falls through with the offer they took initially. So if any of the contingencies allow the buyer to back out or if the seller has a kick-out clause, they might be able to accept another offer when the deal doesn’t go through.

How Often Do Contingent Offers Fall Through?

So you know what contingencies are, but you’re probably wondering how often contingent offers fall through and whether it’s worth it to make offers on these properties. The fact is, once an offer gets accepted, most deals are likely to go through. According to a chart on SuperMoney that visualizes data from the National Association of Realtors, only about 5% of deals don’t go through due to real estate contingencies.

That’s a pretty small percentage, but if you’re ready, you might be able to take advantage of the 5% of deals that are slipping through the cracks and might have to start the process all over again.

When Should You Waive Contingencies?

Contingencies can protect you, the buyer, when purchasing a home. But they can also make your deal look less appealing to a seller, so it may be beneficial to waive contingencies in some cases. In a seller’s market, you could consider waiving the appraisal contingency or the home sale contingency, which means the seller doesn’t have to worry about these issues. Waiving contingencies takes careful consideration, so only waive the ones you know you don’t need.

Getting preapproved for financing could eliminate the need for a financing contingency, but make sure you’re certain you can get the amount you’re preapproved for. Otherwise, you could get stuck buying a house you can’t afford. It’s rarely advisable to waive a home inspection contingency, as you want to know about any issues you can’t see. If you were very confident in your abilities to do a DIY home inspection, you might feel comfortable eliminating the home inspection contingency from your contract. Your real estate agent can walk you through contingencies and which ones you need for your deal.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.