Contingency Clauses: What Buyers and Sellers Must Know Before Signing a Real Estate Contract

When buying or selling a home, you may expect the process to be a pretty straightforward event. However, while most home buying and selling opportunities unfold more or less in a similar way, there are times when items such as a contingency clause might come into play.

Here's what you need to know about contingency clauses and how they might affect you during the buying or selling process.

What is a Contingency Clause?

Knowing what a contingency clause is before you begin the process of buying or selling a home provides you with useful information that is important to be aware of. In its simplest terms, a contingency clause states that the real estate contract is legal and binding only if a particular action or condition has been met. Because the outcome of a contingency clause can significantly impact the selling and purchasing of a home or other real estate, it is important to know if your contract contains one and how it affects you if the contingency is not met.

Common Contingency Clauses

While a contingency clause might be included in a real estate contract for nearly any reason, most can be categorized within four broad categories.

1. Due Diligence Contingency

The due diligence contingency is also often called an inspection contingency. This contingency clause usually provides the buyer with a set amount of time -- often five to ten days -- to have the home inspected by a professional inspector. A professional home inspector objectively looks at the property and inspects each of its components such as the plumbing, the overall structure, the electrical system and more.

Depending on the inspector's findings (and the wording within the contingency clause), the potential home buyers may either cancel the contract or negotiate other terms.

This type of contingency clause usually is written to protect the buyer and may enable them to request more time for further inspection, approve the inspection findings and continue with the home purchase, request repairs or other accommodations if the seller is open to that idea or back out of the contract entirely and have their earnest money returned to them.

2. Home Sale Contingency

The home sale contingency usually provides the home buyers with a set amount of time to sell their current home and then settle the affairs involved in that process. The purpose of allowing the buyer to sell their own home is to provide the buyer with the ability to finance the purchase of the new home. Most home buyers cannot finance two homes with two mortgages. Therefore, the existing home must be sold first before the contract can move forward.

Home sellers should be aware that this type of contingency clause may take the home off the market for quite some time (the time frame is usually explained within the contingency clause) as the buyers attempt to sell their own home.

3. Appraisal Contingency

In most cases, under the conditions of an appraisal contingency, the property must be appraised at a certain amount or the buyer may be able to cancel the contract. If the buyer chooses to cancel the contract, their earnest money is typically refunded to them. However, some contingency clauses allow the buyer and seller to negotiate to reach a mutually-agreed-upon compromise. For example, language might be included in the appraisal contingency that the buyer can still purchase the home even if it was appraised for below the selling price.

Additionally, should the appraisal fall below the agreed-to purchase price, the seller might be afforded the opportunity to reduce the selling price so that it falls more in line with its appraised value.

4. Mortgage Contingency

A mortgage contingency is also known as a financing contingency. The purpose of this type of contingency clause is to provide the buyer with enough time to obtain ample financing to purchase the home - if they are not buying the home for cash. This contingency often stipulates a specific time frame during which the potential buyer must secure appropriate financing.

In many cases, the contingency stipulates that the buyer must let the seller know by a special date if they are unable to obtain financing. If the buyer is unable to obtain financing, the contingency usually stipulates the next steps. This could include the return of earnest monies and the subsequent cancellation of the contract.

Contingency clauses often offer the buyer, and sometimes the seller, a great deal of protection. They are an important concept that should be understood by both parties, and be explained to you by your real estate agent, when it comes to buying or selling a home.