Contingency Clause: What it is, How it Works, Real Estate

James Chen, CMT is an expert trader, investment adviser, and global market strategist.

Ebony Howard is a certified public accountant and a QuickBooks ProAdvisor tax expert. She has been in the accounting, audit, and tax profession for more than 13 years, working with individuals and a variety of companies in the health care, banking, and accounting industries.

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A contingency clause is a contract provision that requires a specific event or action to take place in order for the contract to be considered valid. If the party that's required to satisfy the contingency clause is unable to do so, the other party is released from its obligations.

Contingency clauses are frequently used in real estate transactions that might require a buyer to obtain financing, get an appraisal, or home inspection before agreeing to buy a home.

Key Takeaways

• A contingency clause is a contract provision requiring a specific event or action to occur in order for the contract to be considered valid.
• If the party required to satisfy the contingency clause is unable to do so, the other party is released from its obligations.
• When buying a home, contingency clauses can include property improvements or passing inspection must be done; otherwise, the buyer can back out of the contract.
• Contingency clauses in real estate might require the buyer to obtain financing, the home to pass inspection, or an appraisal to be done.

Understanding Contingency Clauses

A contingency clause refers to an event that may occur if certain conditions have been fulfilled, but if those conditions are not met, the other party does not need to fulfill their obligation.

A contingency clause can be inserted into a contract to benefit either party. Courts often require a good faith effort in contracts that contain these clauses. A contingency clause can be considered a type of escape clause for those involved in the contract. It allows one party to cancel a deal if certain requirements are not met, though the party benefiting from the clause has the right to waive it.

Examples of Contingency Clauses

Contingency clauses are found in everyday transactions, including the following:

• Business transaction: A contingency clause might state that a payment for an invoice must be made 30 days following the product's delivery to the buyer. If the payment is late, the seller has the right to charge a late fee or penalty.
• New employment: Contingency clauses can be written into conditional offers within employment contracts whereby a job offer is contingent on the applicant passing a drug test or background check.
• Job performance: A contingency clause linked to job performance can include a sales goal that stipulates an employee must generate a specific number of new clients or revenue to earn a performance bonus.
• Legal fees: Attorneys can often have a contingency clause built into their compensation in which legal fees are only paid if they win the case for their client.
  

Contingency Clauses in Real Estate

Contingency clauses are often used in real estate transactions whereby an offer to buy or sell a home is contingent on specific terms within a contract being satisfied.

Buyer Financing

A contingency clause in a real estate transaction may require the buyer to obtain financing before the seller transfers the deed. If the buyer cannot bring together sufficient funds to complete the sale, then both parties may have the right to walk away from the deal.

Property Conditions

A homebuyer may have a contingency written into an offer to buy a house only if it passes inspection. An unsatisfactory inspection report can result from issues that were not detected when the buyer first looked at a property. There may be damage to the foundation or hidden problems such as termites.

Also, if there's a history of flooding, mold could be present during an inspection, triggering the contingency clause. The seller could be compelled to pay the expenses necessary to mitigate these issues. If they do not, the buyer may have the right to back out of the transaction or demand a reduction in the home's selling price.

Sale and Settlement

Various types of sale and settlement contingencies can include a buyer's offer is contingent on selling their existing property within a reasonable time frame. If the buyer cannot, the seller can market the property to other potential buyers.

In some cases, the buyer may have already sold their property and is awaiting settlement of the transaction. A contingency clause might allow for the transaction to close, but if it does not, the seller has the option to cancel the sales agreement with the buyer.

Appraisal Value

The appraised value of the property could also set off contingency clauses as well. An appraisal is an independent assessment of a home's property value by a professional appraiser. The bank or mortgage lender will send an appraiser to assess its value.

An appraisal can help the bank ensure that they don't lend more than the house is worth. If the property is determined to be of lower value than the negotiated sale, the mortgage lender is not going to loan at the selling price. A low home appraisal could trigger a contingency clause, allowing the buyer to request a lower price or back out of the transaction.

Appraisal bias is when an appraiser uses a homeowner's race or ethnicity or the ethnic demographics of the neighborhood when calculating a home's value. Discrimination during the appraisal process is prohibited under the Fair Housing Act and Equal Credit Opportunity Act.

If you believe you have experienced discrimination, call the Appraisal Complaint National Hotline at 1-(877) 739-0096.

Review the Fine Print

It's important to review the wording of a contingency clause. A loosely worded clause may provide either party with too much latitude in determining whether the terms of a contract should be executed. A contingency clause should clearly outline the conditions, how the conditions are to be fulfilled, and which party is responsible for fulfilling them. The clause should also provide a timeframe for what happens if the condition is not met.

What Is an Example of a Contingency Clause?

A contingency clause can include a buyer agreeing to purchase a home as long as it passes inspection. If the inspection fails or shows issues that were missed during the initial walk-through, the seller might be required to make the repairs or discount the sales price to reflect the repair costs.

How Long Is a Contingency Clause for a Mortgage?

Typically, a contingent period might be 30-to-60 days, depending on the requirements and the issue within the clause.

What Are Mortgage Contingencies?

A buyer may need to have financing approved by a mortgage lender as a contingency for proceeding with the purchase of a home. Also, a buyer might have a contingency that states that their existing home must be sold before purchasing a new home.

The Bottom Line

A contingency clause requires specific conditions or criteria to be met before a contract between two parties can go into effect. If a contingency clause is not satisfied, the other party may have the option to withdraw from the transaction or receive compensation. Home buying contingencies include buyer financing, whereby the buyer must have approval from a mortgage lender to proceed with buying or putting an offer on a home.

1. Cornell Law School, Legal Information Institute. "Contingency."
2. Appraisal Complaint National Hotline. "Help on Where to File an Appraisal Complaint."
3. MyCreditUnion.gov. "How to Challenge a Home Appraisal?"

An FHA Single Family Title II is a type of mortgage issued by the FHA under Title II of the National Housing Act for a single family.

A conditional offer is an agreement between a buyer and a seller that an offer will be made if a certain condition is met.

Shared equity finance agreements occur when two parties purchase a primary residence because one party is unable to purchase the residence on its own.

A home equity agreement is a contract between a homeowner and an investor. The investor provides funds to the homeowner, who agrees to pay the money back and share any appreciation in the home's value.

A bidding war is a situation in which potential buyers of a property vie for ownership via a series of increasing price bids.

The home equity prepayment curve is a scale to measure the prepayment rate of home equity loans. It has a 10-month seasoning ramp before reaching a constant rate after that.

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