Contingencies are written into your home purchase contract, and usually mandated at least in part by your lender. But what are contingencies, and how do they protect you and the lender if a loan falls through?
The most common contingencies
While a few contingencies may be solely for your benefit, most are required by the lender and must be cleared by underwriting before your home loan is approved. Here are the five most likely to be written into your home contract:
Bad home inspection
A home inspection protects you, the buyer/ It has to be completed by a third party, and should cover the entire house from roof to foundation and all major systems like electrical, plumbing, and HVAC.
You’ll get the home inspection report and don’t have to share it with anyone. Giving a copy to your lender means they have to send it to underwriting, and even the smallest little thing can be seen as an issue.
It’s better to make a judgement call based on the inspection report as to whether or not the issues, if any, are easy to fix. You may be able to negotiate a lower price with the seller if it looks like there will be expenses associated with making the home ready to move into. You might also be able to make them do repairs, but ensure this can be completed before closing.
If the home inspection report shows more issues than you are prepared to deal with, the inspection contingency lets you walk away without penalty and get your escrow money back. You’re only out the cost of the inspection.
Low property appraisal
Your lender wants to make sure the house is worth the asking price, and will order an appraisal which you have to pay for. The appraisal is another third party responsibility. You, the seller, and your lender will all get a copy of this report.
If the appraisal comes in too low, you can put more money down if you think the house is worth it, or walk away using your appraisal contingency, which means you’ll only be out the money you’ve sunk into the appraisal and home inspection.
You may also be able to get the seller to come down on the price if the appraisal is low. This is likely if they don’t have many bidders, or all the bidders know the house appraised low. This can go the other way if the home has desirable aspects, like being in a desirable school district, and you could end up in a bidding war.
Note: Your down payment will be calculated using the lower of the appraised value or the purchase price. If you end up with a down payment that is less than 20%, you’;ll have to purchase PMO to protect the lender due to lower equity in the home.
Denied loan
If something happens during loan approval and underwriting that causes your loan to be denied, you can be in a tight spot. Having a complete preapproval done can reduce the risk of this happening. However, in case of an unforeseen issue like a sudden job loss, a financing contingency can let you walk away if your loan is abruptly denied.
Issues with a title
If there is a title dispute, you may want to get out of the contract rather than wait through litigation or risk losing your home right after buying it. Title problems usually fall under financing contingencies as a lender won’t approve a loan for a house with an unclear title. However, if you’re purchasing a home with cash, you definitely need this contingency.
Current home not selling
Finally, if buying a new home hinges on selling your current one, you may want to put in your contract that if your old home doesn’t sell before closing, you can walk away without penalty. Sellers typically aren’t too keen on agreeing to this unless they have had no other offers and are happy to wait for you to sell your home if it means they can sell theirs.
Underwriting will clear lender mandated contingencies one by one. You are responsible for deciding whether your contingencies are met. Contingencies are there to protect you, but ideally everything will go smoothly and you won’t need them.
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