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When you’re in escrow, it’s very important to understand the contingencies written into the real estate contract. This is an important part of the process for both buyers and sellers. Plus, not having a complete understanding can kill the deal or cost you money.
A contingency is a condition of a contract that governs when and under what circumstances a buyer can cancel the contract. It also covers what happens to the buyer’s earnest money or deposit should they cancel.
Generally speaking, a buyer can cancel the purchase contract at any time during their contingency period. If they do, they should receive their full deposit back. However, contingencies are removed, the seller is entitled to keep the buyer’s deposit if the buyer cancels the contract. The typical deposit in Long Beach is around 1%-3% of the purchase price. So misunderstanding your rights when it comes to canceling a contract can be a costly mistake.
Standard Contingency Types
There are three main contingency categories in the standard California Residential Purchase Agreement.
1. Inspection Contingency
The “inspection” contingency allows buyers to do many investigations. It covers the buyers’ physical inspection and the title report or homeowner’s association documents. Generally, buyers have 17 days to remove the inspection contingency. However, the time period can be changed in the agreement.
2. Appraisal Contingency
An appraisal contingency only applies to purchases being made with a mortgage loan. The mortgage lender will send an appraiser to visit the property to determine its market value. By default, the appraisal contingency is 17 days. Like the inspection contingency, the buyer has the option to cancel the contract. But only if the appraiser doesn’t value the property at the offer price given.
3. Loan Contingency
Like appraisal contingencies, loan contingencies only apply to purchases being made with a mortgage loan. By default, the loan contingency is 21 days. It gives the buyer an option to cancel if they are unable to get a mortgage loan approval. The length of this contingency is frequently shortened either in the contract or subsequent counteroffers.
17-day and 21-day time frames are generally the default. But sellers or buyers can negotiate shorter (or longer) contingency deadlines. This is not uncommon for buyers and their agents in a competitive market. It’s used as a way to make their offer more appealing to sellers. If you’re a buyer and looking to shorten contingency periods, there are two things you need to look out for.
- Confirm with your home inspector how quickly you can get an inspection report.
- Talk to your lender about the time frame needed for an appraisal and for loan approval.
Other Contingency Types
In addition to the primary contingencies, several others are commonly added to real estate contracts. For example, if a buyer already owns a home that needs to be sold in order to purchase the seller’s property. The buyer can add a contingency to that effect. This is known as a Contingency for Sale of Buyer’s Property. It’s typically incorporated into the purchase contract with a separate form known as a contract addendum. There is a similar form which gives the seller a right to cancel if they are unable to find themselves a replacement property. (Yes, sellers can have contingencies in the contract too!)
In California, there is a process of “active contingency removal.” This means buyers must remove them in writing. In other words, a contingency is not automatically removed. This applies even if the time frame for their removal passes. The buyer has to provide one, or more, signed Contingency Removal forms. Each one removing, or more, of the contract contingencies. Once the buyer has removed all of them in writing, they can no longer receive a refund of their deposit. This applies even if they cancel the contract, or do not go through with the purchase for any reason. If the buyer cancels after each contingency has been removed, the seller is entitled to retain the earnest money deposit as “liquidated damages.” This is provided both parties have initialed this section in the agreement.
Notice to Perform
What happens when the contractual deadline for the buyer to remove contingency passes and the buyer has yet to remove the contingency in writing? At that point, the seller can issue a Notice to Buyer to Perform. This notice must be provided in writing with receipt acknowledged by the buyer. It gives the buyer 48 hours to remove their contingency or cancel the transaction. If the 48 hours pass and the buyer doesn’t remove the contingency, then the seller has the right to cancel the agreement unilaterally.
Waiving A Contingency
Under certain circumstances, it is possible to waive the inclusion of a standard contingency. For example, if a buyer has a very large down payment, the lender may not require an appraisal. Therefore, the appraisal contingency may be waived. A buyer purchasing a home with cash (and therefore no mortgage loan), can waive both the appraisal and loan contingencies, as neither applies. The inspection contingency likewise can be waived. Just be sure you understand the risks involved and discuss them with your agent.
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