Without contingencies, buying and selling a house would be a much riskier affair both for the buyers and the sellers, and all other parties involved. Though at first glance contingencies look like another headache to get through on your way to closing on that home for sale in Toronto, in reality, they keep you, the buyer, safe and act as an added layer of trust in the whole home buying transaction. There are usually three contingencies included in the purchase agreement. We’re going to cover those and a couple more and give you an idea of when to use contingencies and when not to use them.
First off, what is a contingency anyway?
In the real estate sector, a contingency is a clause or condition in a purchase agreement that specifies what must happen or needs to be done for the contract to be legally binding. Before the contract becomes valid, both the buyer and seller must accept the terms of each contingency and sign the agreement. A contingency clause can also allow the parties to terminate their agreement under certain conditions that the buyer and seller have agreed on.
Before anything, you need to keep in mind that all of these contingencies come with a time limit. In almost every case, the buyer needs to perform whatever actions are necessary to complete the conditions of the clause within a set, written time frame. Time is of the essence when it comes to real estate, and if you fail to meet the time requirements, there’s not much you can do about it.
Contingencies work best for buyers in a Buyer’s market. You want to already have leverage over the seller before you start protecting yourself with contingencies. In a seller’s market, where most homes get multiple offers, buyers with contingencies will almost certainly be competing against buyers without contingencies, and those without contingencies are much more attractive to sellers.
Contingencies make sure buyers and sellers keep to their word. Though they can be a headache, they protect buyers and sellers from purposefully or inadvertently taking advantage of one another. In some instances where homebuyers are trying to get into extremely competitive markets like Toronto’s Casa Loma neighbourhood, it’s a good idea to limit your contingencies to as few as possible. If you have to choose one contingency, keep the financing contingency.
1. The Financing Contingency
Though no contingency is guaranteed to show up in every transaction, the financing contingency is by far the most common. The financing contingency gives homebuyers a set amount of time to secure a mortgage or a loan for the home they want to buy from the seller. Under the terms of the contingency, if a buyer cannot secure a loan or mortgage within that time frame, they can terminate the deal without facing a penalty.
Buyers want this contingency because it gives them time to sell their current home and secure funds before buying a new home. Unless they’re downsizing, most buyers need to sell their current home to get enough money together to buy a new home in the first place, which leads to our next contingency,
2. The Home Sale Contingency
Another protection for buyers (with a big catch), is that the home sale contingency allows buyers to first sell their current home before buying their new home. This contingency protects you (the buyer) because you may back out of the contract without legal repercussions if your existing property does not sell on time.
Now put yourself in the shoes of the seller. Are they going to wait around for you to sell your home (a process which can take many weeks if not months) when they could be getting a better deal from a buyer who’s already taken care of all that? Probably not. In that case, the seller can use another common contingency to protect themselves.
3. The Kick-Out Clause
In hot markets like Toronto or Vancouver, time is of the essence to get the best deal, both as a buyer and a seller. If you (the buyer) try to lock them into a home sale contingency, they’ll likely want to include a kick-out clause.
A kick-out clause gives the seller the right to continue to market their property. If they get an offer from someone else they like, they can give the buyer 72 hours to get rid of their home sale clause. If the buyer either hasn’t sold their current home by then, or lets those 72 hours elapse, then the deal is off, and the seller is free to sell to someone else.
Unless you’re selling in an exceptionally slow market, you (the seller) must make sure you have a kick-out clause. If you’re starting to get a “checks and balances” feel from all this contingency talk, then you’re catching on. Buying and selling homes is an intricate business, and it pays to cover your bases legally if a deal falls through.
4. The Appraisal Contingency
The appraisal contingency is fairly common and useful to the buyer alongside the financing contingency. The appraisal contingency allows the buyer to renegotiate or even back out of a deal if, after having the home in question appraised, the newly appraised value doesn’t line up with the current price set by the seller.
It might help to use an example here to show why it’s a good idea for a buyer to use an appraisal contingency:
Let’s say the buyer and the seller agreed on a purchase price of $500,000, but the appraisal shows that the property is worth only $470,000; those extra $30,000 are the buyer’s responsibility because lenders only loan up to the fair market property value. After the appraisal, you can negotiate the price with the seller, seek extra funding, or step out of the deal.
Make sense? Only choose not to use an appraisal contingency if you’re comfortable paying more for a house than what it’s worth.
5. The Inspection Contingency
The inspection contingency functions virtually the same way as the appraisal contingency. The buyer has an inspector come and have a look at the property in question, see if there are any problems, and based on that inspection, the buyer can renegotiate or back out of the deal without penalty.
Unless you are absolutely desperate to get your hands on the house in question as soon as possible, put this contingency in any deal you make. Even if you’ve toured a house several times, you’re not going to see the same things a house inspector sees. Don’t get saddled with a lemon just because you’re in love with a house, because when the previous owners leave, all the problems with their houses stay behind.
