What Are “Contingencies” in a Real Estate Contract?

When buying or selling real estate in California, understanding contingencies can be crucial for protecting both parties in the transaction. A “contingent offer” occurs when a buyer makes an offer on a home, the seller accepts, but the final sale depends on specific conditions being met. These contingencies are safety nets that allow buyers to back out of the deal if necessary criteria are not fulfilled, often without penalty. Let's dive deeper into the different types of contingencies commonly used in California real estate and why they matter.

Home Inspection Contingency
The home inspection contingency is one of the most frequently included conditions in an offer. It gives buyers the right to hire a licensed home inspector to thoroughly examine the property before committing to the purchase. In California, where earthquakes, wildfires, and older building codes can affect homes, a comprehensive inspection is even more critical. The inspection covers structural elements, plumbing, electrical systems, the roof, and more. If any significant issues are uncovered, the buyer can negotiate repairs with the seller or ask for a price reduction to account for the needed fixes. If an agreement cannot be reached, the buyer can walk away from the deal. In competitive markets, some buyers are tempted to waive this contingency to make their offer more attractive, but doing so can be risky.

Appraisal Contingency
The appraisal contingency protects the buyer in case the property’s appraised value comes in lower than the agreed-upon purchase price. Lenders generally base their mortgage approval on the appraised value, not the purchase price, to minimize their financial risk. If the home appraises for less than the price agreed upon, the buyer has options: they can ask the seller to lower the price to match the appraisal, make up the difference with a larger down payment, or walk away from the deal entirely. This contingency is particularly important in California, where fluctuating market conditions can cause property values to shift quickly.

Mortgage Contingency
A mortgage contingency ensures that the purchase is conditional on the buyer securing financing. This clause states that if the buyer’s loan is not approved within a certain timeframe, they can withdraw from the transaction without losing their earnest money deposit. Given California’s high property prices, many buyers rely on substantial loans, and unexpected changes in financial circumstances or issues with the lender can occur. This contingency provides peace of mind, especially in markets where interest rates are volatile or lending criteria are strict.

Additional Contingencies
While the above contingencies are the most common, California real estate contracts may also include other types, such as:

• Sale of Buyer’s Property Contingency: If a buyer needs to sell their current home to finance the new purchase, this contingency makes the offer conditional on that sale. It protects the buyer from being obligated to own two homes simultaneously if their property doesn’t sell in time. This can be a more challenging contingency for sellers to accept, especially in a hot market.
• Title Contingency:This allows the buyer to review the property’s title report to ensure there are no issues such as liens, easements, or encroachments that could complicate ownership. California law requires a clear title before a property can be transferred, so this is an essential step in the buying process.
• HOA Review Contingency: In properties governed by a Homeowners Association, this contingency lets buyers review the HOA’s rules, regulations, and financial status. California has many properties with HOAs, and reviewing these documents can reveal potential deal-breakers, like restrictive covenants or substantial future assessments.
• Insurance Contingency: This contingency gives the buyer time to obtain a homeowners insurance quote and verify that the property can be insured at a reasonable rate. Given California's history of wildfires, earthquakes, and other natural disasters, some properties may be difficult or expensive to insure. An insurance contingency protects the buyer from being locked into a deal where securing coverage is a significant financial burden or even impossible.

The Role of Contingency Periods
In California, real estate contracts usually specify a timeframe for each contingency to be resolved. Common periods are 17 days and sometimes a few days longer for a loan contingency (21 days). During these periods, the buyer must act diligently to complete their inspections, appraisals, and secure financing. In most cases, the contingencies remain in place until the buyer removes them in writing.  That being said, if they are not removed on time, a seller could send a Notice to Perform giving you a specific time period (usually 2 days) to remove the contingency.

Why Contingencies Matter
Contingencies balance the interests of both buyers and sellers. They provide buyers with essential protections while also giving sellers a clear understanding of potential obstacles to closing. However, contingencies can also affect the strength of an offer. In highly competitive markets like those found in California, sellers may favor offers with fewer contingencies, while buyers need to weigh their desire to secure the property against the risks of waiving protections.

In conclusion, contingencies in real estate transactions are not just contractual formalities; they are strategic tools that can significantly impact the outcome of a purchase. Understanding and carefully negotiating these terms can make all the difference in ensuring a smooth and successful real estate transaction.