What is a Contingency Clause?

A contingency clause is an addition to a real estate contract to let parties back out without penalty under certain circumstances.

A Longer Definition: Contingency Clause

Contingency clauses let buyers or sellers back out of a real estate deal under specific conditions with no legal or financial consequences. They are protection against issues with the home, its title report, buyer qualifications, or anything else that is unknown at the time of offer acceptance.

Most contingency clauses in a real estate contract protect the home buyer, and some protect the seller.

Contingency clauses are particularly important for protecting earnest money. When a contingency clause is activated, the buyer can back out of the contract legally and reclaim their earnest money, which would otherwise be at risk.

The most common contingency clauses in a contract include:

Home Inspection Contingency

A home inspection contingency clause gives home buyers the right to hire a home inspector to identify potential problems with the property. If the home inspection reveals major issues, such as structural damage or outdated electrical systems, the buyer can negotiate with the seller for repairs, a price reduction, or even back out of the deal.

Mortgage Financing Contingency

The mortgage financing contingency clause defines a time window for the buyer to get their mortgage approved. If the buyer’s mortgage cannot be approved, they can withdraw from the contract without penalty. Sellers rarely accept this clause, demanding buyers are pre-approved before agreeing to a contract.

Home Appraisal Contingency

The home appraisal contingency ensures the home’s appraised value at least meets the agreed sales price. Should the home appraise for less than its purchase price, the buyer gets the right to renegotiate the price, make up the difference in cash, or opt out of the purchase.

Sale of Current Home Contingency

The sale of current home contingency is linked to the buyer’s inability or unwillingness to purchase a new home before selling their existing home. The buyer can safely exit the contract if their current home doesn’t sell within the specified period.

Title Contingency

A title contingency is included to protect the buyer from future legal disputes over property ownership. It ensures the property title is free from liens, encumbrances, or legal issues. Title contingencies are common in all-cash deals.

Contingency Clause: A Real World Example

Imagine a first-time home buyer who makes an offer to buy a home. Their offer letter contains a home inspection contingency to which the seller agrees. Both parties sign the contract so the home buyer gives their earnest money deposit on the home and hires a home inspector to examine it.

During their home inspection, the home inspector uncovers water damage and a weak foundation, in addition to faulty plumbing. The buyer realizes the risk of buying the home and the high cost of repairing the problems.

They exercise their home inspection contingency and back out of the deal, getting their earnest money back in full.

Common Questions About Contingency Clauses

What happens if a home buyer can’t meet a contingency in the contract?

If a buyer cannot meet a contingency, such as getting a mortgage approved or selling their current home, they can typically back out of the contract without losing their earnest money.

Are contingency clauses negotiable?

Yes, contingency clauses are negotiable. Both buyers and sellers can negotiate the terms, including the time frame and conditions, of each contingency.

Can a buyer add contingencies after an initial offer?

Adding contingencies after an initial offer typically requires a new agreement or an amendment to the existing contract, which both parties must agree to.

What are the standard contingency clauses in a real estate purchase contract?

Contingency clauses in a real estate contract vary based on state laws and local real estate customs, so there are no standard clauses.

Is it common to have multiple contingencies in one contract?

Yes, it’s common to have multiple contingencies in a single real estate contract, each addressing different aspects of the transaction and offering specific protections.