What Is A Contingency In A Real Estate Transaction And Why Should You Care?
I use the term contingency almost daily in my real estate practice, but what does it really mean. What is a contingency? Let’s look at the definition. The Google Dictionary describes a contingency as “a provision for an unforeseen event or circumstance.” Another source says “a contingency is a potential negative event that may occur in the future.” The definition I like best says, “contingencies are provisions that allow a real estate contract to be terminated.” Yes! “Contingencies are provisions that allow a real estate contract to be terminated” describes it best for me, in my real estate world. The fact that “contingencies are provisions that allow a real estate contract to be terminated” and money can be lost, is why you should care about the contingencies in your real estate contract.
The Arizona contract has four contingencies, however, there is no limit to the number of contingencies that can be included in a real estate contract. For example a buyer can make an offer contingent on the sale of their current residence. This contingency is not in the Arizona Association of Realtors Contract (AAR) contract. However, buyers are certainly welcome to make an offer “Contingent Upon The Sale Of A Property.” In this market, most seller’s would not accept an offer with a contingency to sell a property. However, if the property is under contract, with an anticipated close date, the seller might be more likely to accept an offer “Contingent On The Successful Close Of Escrow.”
Another contingency I see is in transactions where a buyer needs or wants another party to approve the purchase before it becomes binding. For example, a first time buyer finds a house they love and want their dad or mom to see it and approve. Another example is a spouse who is in Phoenix looking at homes and the other spouse is in Timbuktu. The spouse in Phoenix finds a property they love. They send the spouse in Timbuktu a picture and a video of the property. The spouse in Timbuktu says, “I like it but I want to see it before I agree to purchase it. I will be there in two days, let’s look at it then.” In the current hot seller’s market, a nice property will be long gone and under contract by the time Dad or Mom gets here or when the spouse from Timbuktu arrives in two days. An astute agent would suggest that the potential buyers make a strong offer for the property, Contingent Upon The Approval of A Third Party, (Dad or Mom or the spouse), within 72 hours of the contract acceptance. If it is a strong offer, from a highly qualified buyer, the seller would probably accept the offer with an agreement that the property is to continue to be marketed and the seller will be accepting backup offers.
As you can see, we have discussed three potential contingencies that could be included in a real estate contract. The first was the “Offer Contingent On The Sale Of A Property.” The second was the “Offer Contingent On The Successful Close Of Escrow” and the third was the “Offer Contingent On The Approval Of A Third Party,” We have discussed three contingencies and we haven’t even mentioned the four main contingencies that are included in the AAR contract. The number of potential contingencies is endless. But don’t forget, “Contingencies are provisions that allow a real estate contract to be terminated.” However, astute real estate agents and brokers should be able to suggest potential contingencies to facilitate a transaction, protect the interests of their clients and explain their ramifications in the context of the real estate contract.
The first contingency in the Arizona Association of Realtors Contract (AAR) is the “Loan Contingency.” It appears in Section 2. FINANCING, Sub-section 2b. lines 70 to 75. It states that “2b. Loan Contingency: Buyer’s obligation to complete this sale is “contingent upon” Buyer obtaining loan approval no later than three (3) days prior to the COE Date.” It further states that No later than three (3) days prior to the COE Date, Buyer shall either: (i) sign all loan documents; or (ii) deliver to Seller or Escrow Company notice of loan approval without PTD conditions AND date(s) of receipt of Closing Disclosure(s) from Lender; or (iii) deliver to Seller or Escrow Company notice of inability to obtain loan approval without PTD conditions.
In summary, the Loan Contingency gives the buyer until 3 days before the Close Of Escrow date to sign the loan documents, or deliver proof of approval and associated documents and continue to close the escrow or deliver to the Seller or Escrow Company notice of inability to obtain loan approval on the appropriate forms. The bottom line is, if you miss any of these steps or their timelines, the buyer can and will lose their earnest money. So my next question is, do you really want your cousin to be your real estate agent. Pick your agent wisely.
The second contingency in the AAR Contract is the “Unfulfilled Loan Contingency.” It appears in Section 2. FINANCING, Sub-section 2c. lines 76 to 82. It states that “2c. Unfulfilled Loan Contingency: This Contract shall be cancelled and Buyer shall be entitled to a return of the Earnest Money if after diligent and good faith effort, Buyer is unable to obtain loan approval without PTD conditions and delivers notice of inability to obtain loan approval no later than three (3) days prior to the COE Date. So the earnest money is refunded if the buyer gives appropriate notice within the timelines.” Again, if you miss this step and it’s timelines you can and will lose your earnest money. Do you trust your agent to protect your money and your interests?
The third contingency in the AAR Contract is the “Appraisal Contingency.” It appears in Section 2. FINANCING, Sub-section 2l. lines 107 to 110. It states that, “2l. Appraisal Contingency: Buyer’s obligation to complete this sale is contingent upon an appraisal of the Premises acceptable to lender for at least the purchase price. If the Premises fail to appraise for the purchase price in any appraisal required by lender Buyer has five (5) days after notice of the appraised value to cancel this Contract and receive a refund of the Earnest Money or the appraisal contingency shall be waived, unless otherwise prohibited by federal law.” This is pretty straight forward. A property has to appraise or the buyer can cancel the contract and have their earnest money refunded. The buyer has, at their option, five days to give notice during which time a good agent or broker would question the appraisal and start a potential negotiation with the seller to re-negotiate the price. If the price can’t be re-negotiated, the buyer has the option of making up the difference between the contracted price and the appraised price and proceed to close. A good agent can navigate a buyer and seller through their best options.
The fourth contingency in the AAR Contract is “The Inspection Contingency.” It appears in Section 6. DUE DILIGENCE, Sub-Section 6a., Lines 213 to 224. It states that, “6a. Inspection Period: Buyer’s Inspection Period shall be ten (10) days or ___________ days after Contract acceptance.” During the Inspection Period Buyers, at Buyer’s expense, have the opportunity to have all aspects of the property inspected with regard to condition, value, wood destroying organisms, sewer connection, Swimming Pool Barrier Regulations and any items about which they have concerns.
The Buyer has 10 days to complete their inspections and submit a “Buyer Inspection And Seller Response Form” (BINSR) to the Seller. The Buyer’s options are 1. Canceling the contract, 2. Accepting the property or 3. requesting repairs and replacement of disapproved items. The Seller has five days to respond to the buyers request for repairs. The Seller can agree to the requested repairs or negotiate the repairs or monetary compensation in lieu of repairs. If the seller is unwilling or unable to complete the requested repairs, the buyer may cancel the contract and have their earnest money refunded. A competent agent will navigate you through the inspection timelines and protect your interests.
Contingencies produce real concerns for Buyers and Sellers. The questions are always lurking in the back of their minds. Will it appraise? Will there be any major problems with the inspection? The concerns are valid. More contracts fall out of escrow over Inspection Contingency and Appraisal Contingency issues than for any other reason.
A Buyer can remove any of the contingencies to make an offer more attractive to a Seller. Yes, they can even strike through and remove the contingencies in the contract. By removing a contingency or contingencies, a Buyer increases their liability. However, if they can absorb the liability, they can a gain competitive advantage in a negotiation to purchase a property. Removing a contingency removes one more worry from the seller’s list and gets them one step closer to their goal of selling the property and moving on. Removing a contingency increases a buyer’s liability, however, removing a contingency or contingencies can be a strategic tactic for a buyer to win a contract.
So do you have a better understanding of the contingencies and the potential contingencies in a real estate contract? Do you understand now, more than ever, why you should care about the contingencies in your real estate contract?
Pick your real estate agent wisely!
I am available for any questions
Henderson Real Estate
*Ahwatukee Foothills is the official name of an Urban Village in Phoenix. Ahwatukee Foothills lies south of South Mountain Park. “Ahwatukee Foothills” is comprised of zip codes 85044, 85045 and 85048. Some confusion occurs when some folks refer to Old Ahwatukee as “Ahwatukee” and “Ahwatukee Foothills” as a separate entity. So, for clarity, when we use the term “Ahwatukee” we are referring to the entire area designated “Ahwatukee Foothills,” including (85044, 85045, and 85048) unless otherwise noted.