I Need To Do What?

Last week I wrote primarily about the financial aspects of the offer contract (the front page). This week, I want to dive into a few items that get a lot of attention, but do not directly influence how much the buyer pays… contingencies.
There are 3 main contingencies people focus on:

  1. Inspection Contingency
  2. Appraisal Contingency
  3. Loan Contingency

Each contingency is in the contract to protect the buyer. And, as the buyer always initiates the purchase contract, it takes a unique market/situation for a buyer to willingly reduce and/or waive them.

It is not uncommon to see offers in the Bay Area with contingencies waived, so I am going to review what that really means:

  1. Inspection Contingency
    1. This is the one that is waived most frequently in our market. Unlike many other markets in California (and across the country), it is not uncommon for a seller to order a hazard report, pest inspection, home inspection, and roof inspection and have it available to prospective buyers before they submit their offer contract. Moreover, many sellers also have the disclosure paperwork filled out in advance, and the buyer can review the documents beforehand. Waiving the contingency (or reducing the standard 17 days) does not mean you cannot perform your own diligence once under contract for the property. But, it does mean that your Earnest Money Deposit is at risk and the seller can retain the deposit as liquidated damages if you fail to purchase the property.
  2. Appraisal Contingency
    1. This contingency is very important for buyers that may not have excess funds after putting forth their down payment. The appraisal contingency, as written into the CAR RPA, can make the contract contingent on a written appraisal of the property by a licensed or certified appraiser at no less than the purchase price. The standard language puts the contingency at 17 days. Ultimately, what this means is that if you offer a price for the home, and a licensed appraiser comes out and appraises the property for less, the lender will base the loan amount on the appraised value (and not necessarily the purchase price if it is higher). So, for example, if you offer $1,000,000 for a home and are planning to borrow 80% from the bank ($800,000) and the property appraises for $900,000, the bank will only lend you $720,000. If you still want to buy the home, you need to put $280,000 down to make up the difference between the offer price of $1M and the loan amount of $720,000 (not the $200,000 you would have put down if it appraised at $1M).
    2. It is not uncommon for a seller to want you to remove this contingency when the property is “unique” or there are not many comparable sales in the area (especially if they are in worse condition than the property being sold).
  3. Loan Contingency
    1. This contingency is the most feared contingency to waive of any – it means that you are making the contract not contingent on your ability to get financing for the purchase. This is not a real concern when you make an All Cashoffer, but it is if you are looking for financing. There are tons of reasons that a lender may not be willing to lend on a property (condition, unpermitted work, etc.). Waiving this contingency is not advisable unless you are truly confident in your ability to secure financing (and willing to potentially lose your Earnest Money Deposit if you cannot). However, something that is more common in the Bay Area is reducing the days to obtain financing. The standard contract has 21 days for the loan contingency, but that can be reduced (i.e. 14 days). If you are working with a good bank/mortgage broker, you should talk to them ahead of time to see how confident they are in your ability to get a loan on the property. Something to remember is a reduction from 21 days to 14 days does not mean you are forced to pursue the property, it just means that after 14 days the contract is no longer contingent on your ability to get a loan. Likewise, reducing the days of the loan contingency does not mean that the close of escrow needs to take place any sooner than originally outlined in the Purchase Agreement.

Something to note about all of the contingencies, is that the buyer must remove them formally in writing even after the contract is accepted. The language is that on the given day the contingency expires, the buyer must remove the contingency or cancel the Agreement.
If you ever have any questions at all, please do not hesitate to reach out. At MinnGo, we realize that real estate is not something our clients think about everyday. Lucky for you, that is what we live and breath.

Until next time.