Buying your first home is quite an education — plain and simple. Navigating the mortgage loan process, searching for the right home, and negotiating price can be intimidating if you don’t come prepared. Market conditions, whether it’s a buyer’s or seller’s market, set the dynamics for negotiation. An important part of those negotiations are homebuyer contingencies.
Contingencies — that is, conditions of the sale — can be included in your home purchase contract to protect you from the unexpected. These conditions provide an out if the deal goes south. They can even get your deposit back. But, contingencies can also limit your chances of closing if they’re viewed as punitive by the seller.
And, in case you haven’t heard, we are in a seller’s market.
Here are some homebuyer contingencies you may want to consider:
1. Loan approval contingency
If your lender turns you down for a loan, you don’t want to be stuck in a purchase where you lose your deposit — often referred to as earnest money. The best way to avoid having to stipulate loan approval in your contract is to get pre-approved by your lender before you begin your house hunting.
Pre-approval gives your offer an advantage over others where final loan approval may still be in question. The seller will take your offer seriously and appreciate the possibility of closing faster since you’ve already completed two thirds of the steps left in the mortgage loan process before closing can be scheduled.
2. Appraised value contingency
Your loan amount is based on the appraised value of the home you wish to purchase minus the amount of your down payment. Again, with a pre-approval you know what you can afford, so you should be shopping in that price range. Providing the appraiser comes back with a valuation that is equal to the asking price, you should have no problem. But if the value is estimated at higher than the asking price, or the seller has other offers from buyers who are willing to pay more than the asking price, your loan will not cover the full amount you need to buy the home. To do so, you will need to increase your down payment in order to make up the difference.
One way to avoid using this particular contingency is to have your real estate agent review the comps used to determine the asking price as well as other recent sales in the neighborhood. If the numbers are accurate and you’re shopping within your price range, there shouldn’t be a problem. If you’re shopping in a competitive market and are outbid, you should be able to withdraw your offer and have your deposit returned to you as a matter of course.
3. Inspection and repair contingency
Even the most seemingly pristine property may have issues just below the surface. From the foundation to the roof, structural problems requiring expensive upgrades or repairs may be discovered during an inspection. Making inspection results one of your homebuyer contingencies is a way to ensure you’re not left with costly repairs after closing. If you have the funds and serious worries about a home you’d like to buy, you could have an inspection prior to making your offer. But remember, the seller is looking to sell.
Manageable fixes make for good negotiations. The seller may be willing to lower the price to cover the costs or make the repairs prior to closing. If the home you’re considering has multiple offers, this is one of the first homebuyer contingencies to go as other buyers may be willing to risk the possibility of worse than perfect inspection results just to close the deal.
4. Title search contingency
This contingency concerns the property’s history. A title search reveals whether there are any liens from previous owners or their lenders that could call into question ownership of the property down the road. The search also confirms boundaries and identifies any open disputes that could come back to haunt the next owner. If you have real concerns, you can avoid using this contingency by having a search done prior to making your offer. Title information is a matter public record which either yourself, or your attorney could research.
5. Natural hazards contingency
Earthquakes, floods, tornadoes — these are the “act of god” conditions that drive up the cost of insurance. These conditions are also a matter of public record. If the seller doesn’t disclose this information, you should be able to find out whether flood insurance etc. would add significant cost or even prohibit your ability to purchase enough insurance to cover your home in the event of a natural disaster.
If you must utilize one or more of these contingencies, you can limit the impact by setting a timeframe. By doing so, you indicate to the seller that you want to keep the selling process moving forward.
Use homebuyer contingencies wisely. Don’t use them when you don’t need the protection or if the risk is worth the reward. Keep in mind that contingencies work both ways. For example, the seller may need to find and close on a new home before they can sell. As a first time homebuyer your offer would be more attractive than a competing offer contingent on the need to move in as soon as possible.
Don’t forget, the seller wants to make the sale. So be flexible and remember the less contingencies, the more attractive the offer.