Putting an offer on a home and going under contract is a major step toward making what is likely the biggest purchase of your life — so it can be nerve-wracking when there are still unknowns, such as the condition of the home, its true market value and whether or not you’ll be able to secure affordable homeowners insurance.
You have the option to protect yourself when you go under contract by making a contingent offer on a house. Contingency clauses are common in real estate contracts, and they can help protect you from loss of your escrow deposit or even a lawsuit should your real estate transaction fall through.
[READ: Should You Buy a House With Cash?]
What Is a Contingent Offer?
A contingent offer on a home includes a clause that protects the buyer and makes it easier to back out of the deal without financial penalty in certain circumstances. Depending on the type of contingency specified, the buyer could have more power to renegotiate the price if the inspection reveals significant faults in the house, the lender rejects the mortgage application or the buyer is unable to sell his or her current home to free up cash for the down payment.
Types of Contingencies in a Home Purchase Offer
There are contingencies for a wide range of scenarios that can occur while a property is under contract. One new type addresses the increasing cost of homeowners insurance in high risk areas.
Typically, only one or two contingencies are included in an offer, since a seller is less likely to be interested in a contract that allows the buyer to back out too easily.
Here are five contingencies a homebuyer may commonly include in an offer:
— Mortgage or funding contingency
— Home inspection contingency
— Appraisal contingency
— Sale and settlement contingency
— Insurance contingency
Mortgage or funding contingency. The vast majority of homebuyers are only able to afford a home purchase with a mortgage. The National Association of Realtors reports that 80% of homebuyers financed their mortgage as opposed to paying cash, according to its 2024 Home Buyers and Sellers Generational Trends Report.
If you’re worried about a lender denying approval for a mortgage, you may include a mortgage or funding contingency when you make an offer on a home, to avoid losing your deposit should the deal fall apart as a result.
“The legal language in a financing contingency typically includes performance requirements for the buyer, such as submitting documents to the lender and cooperating in a timely manner,” says Amy Adams, associate broker at Berkshire Hathaway HomeServices Georgia Properties in Cumming, Georgia. “I always recommend a financing contingency to buyers using a loan, as issues can occasionally arise during the approval and underwriting processes. While uncommon when a lender performs a thorough preapproval, these issues can still occur, and it’s essential to protect the buyer.”
Home inspection contingency. A common contingency in a home purchase contract focuses on the results of the home inspection. Home inspections are often required by lenders, and many homeowners want them since they can uncover major issues with the house that aren’t obvious.
If the home inspector finds cracks in the foundation or asbestos or mold, for example, the buyer will likely want to renegotiate the price or ask the seller to pay to fix the problem. If negotiations at this stage fall apart, the buyer can walk away.
“A home inspection informs buyers about exactly what they’re purchasing, bringing to light material facts and potential defects that neither the buyer nor seller may have known about when the offer was accepted,” says Adams. “Sometimes, buyers misunderstand the purpose of an inspection. It’s not intended as a tool to renegotiate the purchase contract. Instead, a thorough inspection by a qualified, reputable inspector helps buyers make an informed decision on what is often one of the most significant investments of their lives.”
NAR found that 19% of buyers waived their home inspection contingencies in October 2024, down from 24% the year prior.
Appraisal contingency. For homebuyers getting a mortgage, the appraisal is often a necessary step — a bank doesn’t want to provide more funding for a home than it’s deemed to be worth. An appraisal contingency leaves room for the buyer to try to renegotiate the price if the appraisal comes in too low on the home. If the lender denies the mortgage based on the appraisal, the buyer could walk away from the deal.
Most appraisals are done in-person, but in a few situations, a drive-by appraisal may be what’s ordered by the bank to minimize the disruption to occupants. This includes using public documents, interior photos, details of recent renovations and an exterior examination of the property. Whether a drive-by appraisal is more forgiving than a standard appraisal is unclear and likely varies by appraiser and lender.
NAR found that 7% of contracts in October 2024 experienced delays due to appraisal issues, the same as the year prior.
In the event that a home does not appraise, there are remedies typically spelled out by the appraisal contingency. “Generally a second appraisal is ordered,” says Ying He, a real estate agent at BarbCo in San Francisco. “If the property still does not appraise, the buyer has the option of exiting the contract. In most cases, we would go back to the negotiating table and the parties would meet somewhere in the middle. At this point, neither party would benefit from starting over.”
Sale and settlement contingency. Many homebuyers currently live in a property they own, and need to sell it in order to afford their new house. A sale and settlement contingency stipulates that the buyer must be able to sell a home before being able to close on the new property.
To make sellers more inclined to accept a sale and settlement contingency, the clause often allows the seller to keep his or her home actively for sale. If a better offer comes along while the buyer is still trying to sell her home, the seller can back out of the deal to move forward with the new offer.
With a settlement contingency, the buyer’s purchase will only go forward as long as her sale closes. If the closing of her first home is delayed, the closing of her purchase will be delayed as well.
Because so many buyers need the profits from a home sale to be able to make the down payment on their next house, settlement contingencies may be a necessary part of many real estate contracts.
Insurance contingency. In high risk areas facing skyrocketing homeowners insurance rates, insurance contingencies are becoming increasingly common. These are in place in case homebuyers are unable to secure reasonable insurance rates or coverage through no fault of their own.
“There is a new insurance contingency in California in recent months due to the insurance issues we have been experiencing,” says He. “The insurance contingency is a big deal now. It is referred to at multiple places in the contract.” She says that while it’s an important contingency to use, it can put buyers at a disadvantage if the property is really popular.
[SEE: 15 Secrets to Selling Your Home Faster.]
How Often Do Home Sales Fall Through?
Historically, the share of home sales that fall through before closing has been minimal. According to recent numbers from the National Association of Realtors, 5% of contracts were terminated in the three months leading up to October 2024, which was more or less the same as in the three months prior to October 2023, when it was 6%.
If you’re a seller working with an experienced real estate agent, you’re less likely to face issues with the inspection or appraisal, since the asking price should be close to its market rate determined in the appraisal and major issues with the house will have been fixed or disclosed prior to the inspection.
While there are certainly people who can no longer afford their down payment or have put off purchase plans until their employment is more stable, those who have gone under contract since the start of the pandemic appear eager to move forward.
[READ: Should You Lower the Price of Your Home?]
When to Accept a Contingent Offer on Your House
As the seller, whether you accept an offer that includes a contingency depends on your willingness to endure the different circumstances that may arise.
Many sellers are willing to negotiate over repairs, come down slightly in price post-appraisal or wait to see if the buyer can sell a home before closing. However, you have the right to decline an offer based on contingencies you aren’t willing to accept.
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Your Guide to Making a Contingent Offer on a House originally appeared on usnews.com
Update 12/27/24: This story was published at an earlier date and has been updated with new information.
