When you are in escrow on a property, whether as a buyer or a seller, understanding the contingencies written into the real estate contract is very important. Not having a complete understanding can kill the deal or cost you money.
Contingencies are conditions of the contract that govern when and under what circumstances a buyer can cancel the contract. They also cover what will happen to the buyer’s earnest money or deposit should they cancel.
Generally speaking, a buyer can cancel the purchase contract any time during their contingency period and receive their full deposit back. Once contingencies have been removed, however, the seller is entitled to keep the buyer’s deposit if the buyer cancels the contract. The typical deposit in our area is around 1%-3% of the purchase price. So misunderstanding your rights when it comes to canceling the contract can be a costly mistake.
There are three main contingency categories in the standard California Residential Purchase Agreement.
1. Inspection Contingency
The “inspection” contingency allows buyers to do a whole host of investigations. It covers not only the buyers’ physical inspection but also things like the title report or homeowner’s association documents. Unless the time period is changed in the agreement, a buyer has 17 days to remove the inspection contingency.
2. Appraisal Contingency
Appraisal contingencies only apply 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, it gives the buyer the option to cancel the contract 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.
While 17-day and 21-day time frames are the default, sellers or buyers can negotiate shorter (or longer) contingency deadlines. In a competitive market, it is not uncommon for buyers and their agents to shorten the contingency periods. This is 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.
In addition to the primary contingencies, several other contingencies 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, they 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, we follow a process of “active contingency removal.” This means buyers must remove contingencies in writing. In other words, contingencies are not automatically removed even if the time frame for their removal passes. The buyer has to provide one, or more, signed Contingency Removal forms each removing one or more of the contract contingencies. Once the buyer has removed all of their contingencies in writing, they will no longer receive a refund of their deposit should they cancel the contract, or for any reason not go through with the purchase. If the buyer cancels after all contingencies have 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.
Under certain circumstances, it is possible to waive any or all of the standard contingencies. 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.
Still, have questions about contingencies? Give our team a call at 562.896.2456 or use the contact form below.