Low inventory combined with remote workers relocating to cheaper cities is driving up homebuyer demand across the United States. Most buyers should expect to pay well over list prices, but when bidding wars consist of dozens of offers over asking, this tactic alone doesn’t lead to victory.
To make the offer more appealing, some buyers are waiving contingencies. It’s up to the buyer to weigh the risks and rewards of this homebuying strategy, but professionals who are involved in transactions caution against it.
“If you’re a first-time homebuyer or even a fourth-time homebuyer, you should know what you’re purchasing. You don’t have an Amazon return policy with a home,” warns Linda Grahovec, a title insurance professional.
Related Listening: How to Talk to Homebuyers about Title Insurance
Before you think about removing a contingency, make sure you understand how it will impact your wallet and consider some other alternatives to make your offer stand out.
What is a contingency?
A contingency allows a buyer or seller to back out of the deal without penalties if a requirement isn’t met or unfavorable information about the property is revealed during the inspection period.
Some common contingencies found in the real estate contract include:
- Appraisal
- Financing
- Inspection
What is an Appraisal Contingency?
If a buyer is financing the deal, the lender will want an appraisal of the property to ensure the purchase price is realistic. In the current market, appraisers are struggling to keep up with the bidding wars, so buyers who go in strong may be disappointed to find the appraiser doesn’t agree with an offer thousands of dollars over the list price.
A common approach to deciding a property’s fair market value (FMV) is the market comparison. The appraiser examines recent selling prices for similar properties, called “comps,” in the area to determine the property’s worth. However, in a market with consistent demand pushing prices higher, some appraisers use other metrics like listing activity — did the property receive multiple offers? — and pending home sales to arrive at a number to reflect the true desirability of the property.
Whatever price the appraiser settles on will determine the maximum amount a lender will approve for a mortgage loan.
What happens if the appraisal is lower than the offer price?
Typically, the appraisal contingency allows the buyer and seller to renegotiate the purchase prices or walk away from the deal.
With an appraisal contingency waived, the buyer will:
- Lose their earnest money deposit if they don’t continue with the purchase
- Cover the difference between the appraised value and purchase price
Earnest money deposits range from as low as 1-3% up to 10% of the offer price. Again, this amount is driven by the same market conditions driving up listing pricing. In the first quarter of 2021, the average purchase price of a home was $317,500. If a buyer’s earnest money deposit is 5% of that, that means potentially losing $15,875. Even on the low end of 3%, that’s a loss of nearly $10,000.
For most homebuyers, that’s a massive hit to their downpayment budget.
What is a financing contingency?
A financing or mortgage contingency allows the buyer extra time to apply for a new loan if the original lender doesn’t finalize funding. Usually, it also allows the buyer to back out of the contract and reclaim the earnest money deposit.
The contingency clause will also state a specific time frame to obtain new financing, where the buyer has until that date to end the contract or possibly request an extension. Most sellers want to avoid closing delays, so buyers are removing this contingency from offers.
Apply to multiple mortgage lenders
If you decide to go this route and remove the financing contingency from your offer, here are two things to do first:
- Request at least five loan quotes from lenders
- Get a pre-approval letter from your preferred lender for the offer amount
A pre-approval letter signals to sellers that you’re likely to get the financing needed. It’s wise to do this at the beginning of your home search so you can comparison shop and find the best deal for your home loan.
Research shows that borrowers who submit one additional application can see an average savings of $1,500.
One study from Lending Tree found that borrowers who shop around can save up to $47,560 over the lifetime of a 30-year fixed-rate mortgage.
Not only does this save you money, but it also allows you to pivot to another lender quickly should your first choice refuse to finance the loan during underwriting.
What is an Inspection Contingency?
The inspection or due diligence contingency gives the buyer a chance to use the results of a home inspection to ask for repairs or cancel the contract. A professional home inspection report typically encompasses:
- Electrical
- Plumbing
- Structural
- HVAC
A separate pest inspection is also typically requested. Without these reports, it’s almost impossible for buyers to know if they’re purchasing a dream home or a money pit. Waiving this contingency essentially means you’ll be buying it as-is. Any problems that arise are yours alone to fix.
Inspect but limit demands
Homes are significant investments, and the inspection provides vital information about the state of the property. Instead of waiving this contingency completely, two better alternatives include:
- Ask for the right to inspect but specify that you won’t ask for repairs costing under a certain amount like $1,000 and keep the option to terminate the contract.
- Ask for the right to inspect but limit the maximum dollar amount for any needed repairs and keep the option to terminate the contract.
- Ask for the right to inspect but forfeit your earnest money deposit if the deal is canceled. Losing your earnest money deposit isn’t ideal, but it’s better than being locked into a contract on a home in need of major repairs.
Real Estate Due Diligence in a Hot Market
Well-meaning real estate agents may suggest to buyers in competitive markets to waive a contingency, but buyers need to make sure they understand the potential ramifications. Buying a house is stressful, and waiving some of these contingencies can pile on the anxiety.
Instead of wagering your earnest money deposit, ask your real estate agent if they have any suggestions for creative alternatives. In a hot housing market, it’s challenging to compete for the seller’s attention, but removing contingencies that protect a buyer can backfire.
Ultimately, it’s up to buyers to decide whether or not they are comfortable with waiving any or all of these contingencies when drafting a real estate contact with their real estate agent.
