You’re ready to make an offer on a home, but you need protection in case you run into snags. Contingencies protect you and your lender from issues and give you a way out of the deal if problems with the home or your finances start causing issues with the sale.
The Five Most Common Contingencies
There are five contingencies that are the most common. They’ll be written into your offer and will provide a way for you to walk away from the deal if they aren’t cleared. Most contingencies are mandated by your lender, and must be cleared by underwriting before your home loan is approved.
A home inspection must be completed by a third party. It covers the interior and exterior of the home and its systems, and may include specific inspections for mold or insect damage.
Once the inspection is complete, the report will be made available to you for your review. If major issues arise from the inspection you have the option of backing out of the deal or negotiating with the seller to either lower the purchase price or make the repairs called out in the home inspection.
It is important to note that the inspectors job is to note every little thing they see wrong with the home so be prepared. If there are a lot of minor items noted you may want to negotiate a seller credit or small reduction in the purchase price and deal with fixing the issues yourself after the purchase closes. If however there are major issues such as mold, rot or structural issues it is advisable to either require these issues to be fixed prior to closing or look for another home.
The home inspection is not required to be reviewed by the lender for most mortgage loan programs so do not send the inspection to your lender unless they specifically request it. Once a lender has the inspection, they are required to send the inspection to underwriting and all the issues (even if they’re minor) can cause a major headache in getting your loan closed.
If the seller is asking $250,000 for the home, your lender will want to make sure it’s actually worth that much. An appraisal will also be conducted by a third party, and a report given to the seller, buyer, and lender. The appraisal contingency protects you if the appraised value comes in below the agreed purchase price.
The mortgage company is only allowed to loan up to the fair market value of the home, less your down payment. In a competitive market, you may end up in a bidding war, which means you’ll have to come up with any additional difference out of pocket. The appraisal contingency means you can walk away if needed.
Your down payment will always be calculated using the appraised value or the purchase price, whichever is lower. If you agreed to purchase the home for $250k and planned on putting 20% down to avoid PMI but the appraisal came in at $240k you would have to make up the difference in down payment in order to avoid PMI.
Obviously, before cancelling the deal, you may want to negotiate with the seller to see if you can get them to reduce the sales price due to a low appraisal.
A financing contingency is in place in case your lender turns up something in your finances or credit history that causes your loan to be denied.
If you’re planning on buying your home with a mortgage loan, a preapproval can help prevent surprises at a late stage in the home purchase process. However, even the most thorough preapproval process can miss something, especially if you didn’t fully disclose your finances in your loan application. If you have a large unreported debt that comes to light, your debt to income ratio can change, and this could cause a lender to pull out.
Additionally, life happens and unfortunately timing of things like losing a job can happen during the loan process. Having a financing contingency protects you in the event something unfortunate and unexpected happens.
If there turns out to be a problem with the title that can’t be solved before closing, a title contingency gives you an out. You don’t want to be stuck in the middle of a title dispute on your new home and risk losing it right after you bought it.
Any home you make an offer on should go through a rigorous research process by a title company to look for claims or liens. Once you buy your home, title insurance can help protect you for any claims that arise after you buy your home.
Title issues are generally covered by your financing contingency as the lender will deny a loan if there are title issues that can’t be resolved prior to closing; however, if you’re purchasing the home with cash you want to make sure your real estate agent puts the proper contingencies in the contract.
Sale of your current home
You may wish to insert a home sale contingency, stating that if you can’t find a buyer for your current home within a certain time frame, you can cancel the purchase without penalty. This contingency is increasingly unlikely to be accepted by sellers, especially in a competitive market. However, you might be able to get a seller to agree if they have had no other offers and are motivated to wait for you to sell your home.
As each contingency is cleared by underwriting, you get closer to achieving your dream of home ownership. Contingencies may seem like obstacles in your path, but in reality they are designed to protect you and your earnest money in case of unforeseen pitfalls.
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