Understanding Real Estate Contracts Contingencies Benefits Buyers and Sellers

If there is one overarching thing to be learned from the COVID-19 pandemic, it is this: Have a contingency plan for everything.

The future is always uncertain, but before the pandemic, the future was often taken for granted. Now, everyone is finally starting to accept that the future is the great unknown and that even the best-laid plans may fail to come to fruition.

As such, having contingencies is going to be as much of a part of our everyday lives as having three square meals, or seeing how-to dance videos on TikTok.

That will be no different when it comes to buying or selling a home.

For as long as real estate transactions have taken place, buyers and sellers have had contingencies negotiated into the contract for the sale of a property.

This is done to mitigate risk and is a standard practice. A seller may want a contingency built into the contract that their obligation to sell is only conditional upon their ability to find and purchase another home.

Meanwhile, buyers often make their purchases dependent on positive inspection reports or put a financing contingency clause in the contract if they are, in fact, financing a portion of the purchase price.

These contingencies are put in place to protect a buyer’s and/or seller’s interest in a transaction and provides an “opt-out” escape ladder from finalizing that transaction at a settlement if the contingency was not met or waived.

And now, thanks to the COVID-19 pandemic, contingency clauses are becoming more plentiful in contracts. While they are necessary, there still needs to be some prudence.

Buyers especially have to be careful with their contingencies, as too many could cause their offer to come off as less attractive to a seller. With markets especially competitive, too many contingencies can cost you a chance at buying your desired home.

Also, while contingencies are often clear and concise, they can still be confusing, or even frustrating.

Take, for example, the financing addendum used by the Greater Capital Areas Association of REALTORS® (GCAAR) as outlined in the Washington Post:

While most contingencies are fairly straightforward, the financing contingency addendum used by the GCAAR is complicated and often misunderstood. The addendum creates a term called the financing deadline, by which the buyer must deliver a written loan commitment. Contrary to what sellers might expect, buyers’ failure to meet the financing deadline does not cause the buyer to be in default, does not automatically void the contract, and does not allow the seller to retain the buyer’s earnest money deposit.

If a buyer fails to make a timely loan application, fails to comply with a potential lender’s requests, or otherwise fails to take steps required to obtain a timely lending decision, that can be deemed a default. It can also be considered a default if the buyer intentionally takes steps during the loan process that imperil the loan decision, like quitting a job or incurring large debts to buy a car or other major purchase. In those cases, the seller should have the right to retain the buyer’s earnest money deposit and/or sue for additional damages.

The financing contingency addendum provides that the contract will remain in force until the seller delivers its notice declaring the contract void. Sellers might erroneously conclude that if they want to retain the buyer’s earnest money deposit, they should send a notice declaring the contract void, but another GCAAR contract clause states that is not the case: “If this contract becomes void, without default by either party, both parties will immediately execute a release directing that the deposit be refunded in full to the buyer.”

If facing this kind of situation, a smart seller should seek to modify the contingency to make the circumstances clearer. That would allow them to retain the buyer’s deposit and stipulate when they would have to return it.

A seller should be understanding of the buyer’s need for time, but at the same time not allow for too much time to lapse for the sale.

In other words, give a buyer 10 days to apply for financing and 30 days to provide proof of a lender committed to writing the loan, for how much – including an interest rate (fixed or adjustable), and what is the term of the loan.

On the other hand, buyers need to consider their deposit and the risk attached to it. Obviously, the larger the deposit, the better the offer is, but then the buyer has to meet the financing deadlines.

As such, buyers would be better off working with potential lenders in advance of making an offer for a property to guarantee the deadlines get met and the eventual deposit isn’t at high risk of being lost. Getting a pre-approval from a mortgage lender is better for a buyer than just being pre-qualified. Garnering a pre-approval letter from a lender to be included in a purchasing offer certainly strengthens the offer.

Both buyers and sellers understanding the financing process, how contract contingencies work, and what each other’s rights are within the language of that contract will make for a smoother transaction between both parties and at the same time mitigate the risk of a deal falling through and dealing with the ramifications that come when that happens.

August 2020

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