August 25, 2022
When searching for a new home in a competitive market, odds are, you feel the pain of the ongoing housing shortage. In 2021, Zillow found that the typical U.S. homebuyer made two offers before one was accepted, up from one in 2018 through 2020. There are stories of buyers making offers on several homes and even giving up their search after 20 offers were unaccepted. In hot markets, homes receive several offers. Recently, a California home received over 100 offers in two days. Even as interest rates have climbed, there is still a lack of supply fueling the housing demand, and bidding wars can be brutal. Contingencies and waiving them can be the way to have your offer stand out in a competitive market, but there are risks. Here, we explain the best ways to navigate this strategy in homebuying.
Types of Contingencies in Real Estate
While hundreds of different contingencies are possible, the majority falls into five main categories. These are the most common:
- Inspection. Inspections are made for the buyer and mortgage company. They exist to protect both of them from unforeseen issues like mold, insects and foundation issues. This contingency comes into play after the inspection and allows for additional negotiation to determine who pays for repairs. Alternatively, the buyer can walk away if too much is required.
- Financing. This provides time to apply for a mortgage, and if it falls through, alternatives can be sought, or the buyer can back out. Your financing is not guaranteed with a preapproval, it just begins the underwriting process. The financiers have their own conditions and can deny financing if they are not met. This is when a financing contingency is used.
- Appraisal. This is similar to the financing contingency. One condition of the mortgage company is that the assessment of fair market value is high enough to justify the mortgage. If the sale price is $300,000 but the appraisal is $270,000, the difference needs to be made up. At this point, the contingency comes into play.
- Title. The title is the legal ownership document that shows ownership and any liens against the home. The title must be reviewed to show the title can be cleanly transferred. Sometimes a problem cannot be solved prior to closing, and this is when the contingency comes into play.
- Home sale. This used to be the most common contingency. The buyer is provided a certain amount of time to sell their current home. If unsold, they can back out of the deal and their earnest money will be returned. Sellers dislike this contingency, and it makes an offer very weak. A bridge loan can be utilized to make up for this contingency removal when needed.
Each of the major contingencies has risks if they are waived, and depending on laws and financing, some cannot be waived. The repercussions of waiving each include:
- Financing. Waiving this can be a risk. It depends on your financial position. If you have put 20% down; have a long-time, well-paying job and have excellent credit, the risk is much lower. If rates change drastically or you must supply a higher down payment due to a low appraisal, you may be locked into a home you cannot afford, and you can lose your earnest money.
- Inspection. Waiving this means you lose the right to any additional negotiation for problems that are found. A middle-ground option is a general inspection contingency that gives you the right to void the contract but does not require repairs. If you are getting a fixer-upper and know repairs are needed, it can be waived. The older the home, the greater the risk when waiving this.
- Title. It is advised not to waive this one, and it may not be legal to waive it in some areas. The title search can discover many things about ownership and liens and potentially prevent problems. Waive this one at your own risk.
- Home sale. If your current home’s sale is already complete or has a cash offer, then the risk is lower. The sooner you close, the more critical this contingency could be if you have trouble selling and cannot obtain a bridge loan to cover paying two mortgages for an extended time.
Waiving the Appraisal Contingency
Most lenders will require an appraisal, and if you get an appraiser that uses low comps, you could be in trouble. Hot markets can have houses at inflated prices but not their appraisals. If you don’t think the appraisal will change the asking price, then you are OK. If you can cover any difference with other financing, then you will be OK as well.
Should You Make an Offer With Contingencies?
All of the contingencies are designed to protect you, the buyer/borrower, so you end up with a safe and habitable home that you can afford and not end up paying two mortgages concurrently. Contingencies, however, are an extra hassle for the seller. They increase the time to sell and can ruin a deal altogether. The hotter the market, the fewer the contingencies you can include with an offer and have it still be attractive. Some contingencies you must include, so talk to your agent and lender to determine what you will require for a contingent sale. You may be able to work problems out by increasing earnest money, having a larger down payment, extending the date of the close or ensuring that a bridge loan is possible so you are confident that removing a contingency is doable.
Is It Wise To Waive Contingencies?
Waiving the appraisal contingency can be risky in a competitive market. If the appraisal is $75,000 less than the asking, you will have to cover the gap with cash or other financing or you may need a bridge loan that allows carrying a second mortgage for 6-12 months while waiting for the current home to sell. Having additional financing options in place is a way to waive contingencies and give flexibility if needed.
The inspection contingency is being waived regularly while still moving forward with the inspection. This way, you will understand that you must make repairs, as you know what you are in for and can make them before they get worse.
If you are going to remove contingencies, make sure to work with your agent and lender to navigate the hot market. The riskier the waiver, the better your offer will look, but you may be getting in over your head. Understanding what you are doing and preparing for the worst is the best option.
Having an excellent lender and a knowledgeable real estate agent is key in a hot market.
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