What Is A Contingency Clause When Selling A House?
It’s a magic moment: You, the seller, receive an offer from a buyer to purchase your home. All those weeks of staging, scrubbing windows and polishing kitchen countertops have paid off. But there’s one possible hitch: The buyers are including a home sale contingency clause with their offer.
A contingency clause is an addition to a purchase contract stating that a specific event must happen before a real estate transaction can close. If this event doesn’t happen, the buyers can walk away from the sale, usually without losing what’s known as earnest money, or dollars they deposit in an escrow account to show they’re serious about buying your home.
Most contingencies are routine and rarely derail a sale, but there is one type of home sale contingency that can cause problems for buyers and sellers. This type of contingency states that the buyers must sell their own residence before your home sale can close. And if they don’t sell? They can walk away from their offer without losing their earnest money.
As you can see, the home sale contingency poses real risks for sellers. You’ll have to determine if the offer is attractive enough to take on this risk, all the while wondering if accepting this offer will scare away bids from other possible buyers. You’ll also have to include language in the sales contract that gives you the right to accept another offer should one come in while your first buyers are trying to sell their home.
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How Contingencies Work
Benjamin Ross, a real estate agent with Mission Real Estate Group in San Antonio, said that almost every real estate sale comes with some sort of contingency.
There's the home inspection contingency, which is the most common. This one states that buyers can walk away from a home sale if the home inspection turns up serious problems. The definition of "serious problem" can result in a debate, but this is a contingency all buyers and sellers should consider standard as part of the sales contract.
An offer might come with a financing contingency, too. This states that a sale will go through only if the buyers are able to secure financing from a mortgage lender.
Another contingency called an appraisal contingency allows the buyer to cancel a sale without penalty if the home the buyer is purchasing doesn't appraise for a high enough value.
The home sale contingency, though, is the one that often causes the most problems for sellers. That’s because if the home buying party’s current house doesn’t sell, they don't lose anything; the sellers, however, lose what they considered a “done deal,” in addition to any earnest money they might have received from the buyers.
"I advise sellers not to accept this kind of contingent offer, especially if they are receiving other offers," Ross said. "The only time I would recommend my client accepting a home sale contingency is if they have little or no other interest in their home."
The Earnest Money Problem
The big problem with a pending and contingent offer in a real estate transaction is that the seller is basically waiting, but they’ll have nothing to show for it if it doesn’t work out in the end, as the buyer will be entitled to a refund of their earnest money.
What Is Earnest Money?
When buyers make an offer on your home and draw up a purchase contract, they usually provide earnest money. This is money that they give the seller as a “good faith” payment, meaning that they have every intention of buying the home. The buyer, then, has time to secure financing, confirm mortgage rates and conduct necessary due diligence, such as inspections, title search and property appraisal.
The amount buyers provide can vary, but most deposit somewhere around 1% of the home’s final sales price. If buyers have agreed to pay $200,000 for your home, they might provide an earnest money deposit of $2,000.
What Happens To The Buyer’s Earnest Money?
If the buyers walk away from the real estate transaction, they’ll lose that earnest money. The seller receives the money since the buyers didn’t hold up their end of the “good faith” part. The exception? In home buying, the earnest money is returned if a contingency clause states that they get the money back in the event they back out of the sale. For instance, if the buyer’s home inspector finds serious problems with your home’s foundation, the buyers might be able to cancel the deal and receive their earnest money back with an inspection contingency.
The same thing can happen with the home sale contingency clause. If your buyers give up on selling their home, they can cancel their offer and receive that earnest money back. In a case like this, the seller receives nothing, and instead you’ll have lost both time and money.
Can A Contingent Offer Hurt A Real Estate Transaction?
An even bigger problem arises if other potential buyers see that there’s a pending and contingent offer on your home and pass on your residence as a result. Some buyers won’t put offers on homes that are already under contract, even with a home sale contingency as part of that contract. Because of the home sale contingency, you might miss out on other buyers and still be left with a home to sell.
James McGrath, real estate broker and co-founder of New York-based real estate brokerage Yoreevo, said that a home sale contingency could enact a real cost on sellers. That's because sellers must pay their mortgage, property taxes, utilities and insurance while they’re waiting for the buyers to sell their own home.
And it’s also rare that other buyers will make offers on your home if you first accept a contingent offer, McGrath added.
"As a seller, I would be wary of accepting a contingent offer as it introduces so much uncertainty and has a clear cost to the seller," McGrath said.
The only time McGrath would advise sellers to even consider a home sale contingency is when the buyers are willing to overpay on their home. If buyers are willing to pay $500,000 for a home that's worth $400,000, McGrath mentioned that this might be a good time to accept a home sale contingency.
Right Of First Refusal
There’s a way to protect yourself as a seller. It involves attaching a right of first refusal notice to a buyer's contingent offer.
Say you accept an offer with a home sale contingency, but then you get another offer 3 weeks later without this contingency attached. You must inform the first buyers that you've received a new offer and they have the opportunity to drop their contingency and purchase the home (even if they haven't yet sold their residence). If they aren’t able to, you can accept the new offer.
You may negotiate how much time the first buyers have to consider withdrawing their offer or dropping their contingency. Usually, the right of first refusal notice states that buyers have 24 – 72 hours to make their decision.
This protects you in case you receive a noncontingent offer while your first buyers are trying to sell. Remember, though, that having a contingent offer on your home might still cause buyers to pass on your home. You’ll have to determine whether accepting a contingent offer makes sense.
Michael Edlen, a real estate agent with Coldwell Banker in Pacific Palisades, California, says that these kick-out clauses can make a home sale contingency less of a risk.
"There definitely are times when it may be useful for a seller to negotiate with a contingent offer, especially if the price is good and there are no other offers in hand," Edlen said. "If the market is relatively slow, all the more reason to deal with one."
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