To Have or Forgo a Contingency When Buying a Home
So, contingencies, yes–well as agents, we love them because they help insulate us from future lawsuits. But as a buyer, they can cost you money and they will most certainly cost you a home or two in a competitive market. Here’s why. Faced with a multiple offer situation on a property, buyers will often try and make their offer stand out above their competition. And there are two ways to do that–the terms they offer and the price they pay.
In a multiple offer situation, buyers often exceed the asking price and offer terms that are exceptionally attractive to sellers. Many offers will contain no contingencies for inspections, loans or appraisals.
They’ll purchase the home in its present condition and forgo asking for any repairs. At times they’ll even let the seller rent their home back for a period while they relocate.
On the flip side, some buyers despite the fierce competition for a property, are unwilling to waive having contingencies. Here’s why this can hurt their position: Let’s say for example that a seller has already performed inspections at their cost with reputable inspectors, yet a buyer wants a seven day contingency to have more inspections from what could be not so authoritative or reputable inspectors. This causes many sellers to be leery and it could put the seller in the position of getting poorly done reports which they would then need to turn over to any other prospective buyer.
Of course they would also have to go out to try and refute any erroneous or exaggerated claims in the reports which might take two or more professional opinions before being seen as credible. That’s a lot of wasted time, money and effort and could taint the home in the meantime. So if a buyer is comfortable (as they can be) enough to move forward with the inspections provided, they have an upper
hand.
Case in point, say a seller receives an offer for $1,000,000 with no contingencies and one for $1,010,000 with ten days for inspections and loan contingencies. They’ll very likely take the offer for $10,000 less with a better guarantee of a sure sale. What that means is if your offer contains contingencies, you may have to offer significantly more to garner the seller’s attention–say $20,000. What you effectively have done then is spend $20,000 just to have another opinion, not to mention the added cost of another
inspection–$20,000 that could be better spent on improvements that increase the value of your home, or put towards any issue that might be found later. Alternatively, the seller may simply ask the non-contingent buyer to meet your price and you’re out of a home.
Now with all that said there are times when not having another inspection would be reckless and of course we’d admonish anyone against doing so should that be the case.
As for loan contingencies, this is why it is important to know that you are pre-approved for the price you are offering. You can also always “double app” which is a term for concurrently applying with more than one lending institution to make sure you have a fallback plan. If you get two lenders to agree that your loan will not be an issue then you might feel comfortable enough to not have a contingency for a loan.
Appraisal contingencies run along the same lines. If the home you are buying does not appraise with a particular lender at the value you offered, since the lender will only lend on 80% of the appraised value, you would need to make up 80% of the difference, or go with lender #2 and try and get a better appraisal. There’s risk of course, but if you’re sure you could make up any shortfall, you just mitigated that risk.
Allow me to explain further. Say you put in a non-contingent offer on the above mentioned million dollar home. You goal was to put 20% down and get an 80% loan–which is typical. In this scenario you would be putting $200,000 down and financing the other $800,000. But let’s say the appraisal comes back at only $950,000. Your lender will of course only lend on 80% of the appraised value of $950,000 which would be $760,000 rather than the $800,000 you had hoped for. Are you on the hook for the entire difference? No. just 80% of it. You would now have to put $240,000 down rather than $200,000–not the entire $50,000 shortfall. So bear in mind if you have no contingencies and you are faced with the possibility of losing your earnest money deposit (typically 3% of the purchase price), this is a viable alternative.
That said, we’ve only sold one home in 20+ years where the appraisal fell short and in that case we were prepared that it might. But a bad appraisal is by far the exception to the rule. We estimate 99.8 % of our sales appraise at the offered price and even a few have gone over in recent years. In fact, in our entire career we have never had a buyer lose their earnest money security deposit over qualifying [or anything else]. So albeit that risk exists, it’s limited to your earnest money deposit and furthermore diminished but the odds that you’ll probably never even have to deal with a bad appraisal.
In today’s competitive market environment, it’s difficult to secure a home if your offer contains too many caveats. Contingencies should not be viewed as something you want, they should be regarded as something you need; because any contingency you can do without just made your offer that much better without having to pay more for the home.
Drew & Christine Morgan are REALTORS/NOTARY PUBLIC in Belmont, CA. with more than 20 years experience in helping sellers and buyers in their community. They may be reached at (650) 508.1441 or emailed at info@morganhomes.com.
The information contained in this article is educational and intended for informational purposes only. It does not constitute real estate, tax or legal advice, nor does it substitute for advice specific to your situation. Always consult an appropriate professional familiar with your scenario.
