Contingencies & Liquidated Damages
A contingency is something that protects a buyer (or seller) from having to proceed with a transaction beyond their capabilities. There are many forms of contingencies, but for now we'll start with the three most common, which are found in an offer a buyer makes to a seller of real property.
The San Francisco Bay Area is a highly competitive market where multiple offers are the norm. To give you a better shot at getting your offer accepted you want as few contingencies as possible so the seller sees your offer as close to a "done deal" as possible. Read on to learn when you can waive which contingencies, and when you need their protection.
This contingency, which defaults in the purchase contract to 21 days, protects a buyer in the event that they cannot secure financing to purchase the property.
When is it appropriate? When the buyer has not been pre-approved.
When can it be waived? 1) When the buyer has been fully pre-approved (not just prequalified!) by a reputable lender. This means the buyer has submitted all the necessary documentation to the lender and the lender has verified the buyer's downpayment funds, and analyzed the buyer's portfolio, and assured the buyer that a loan can be secured, 2) If the offer is all cash, 3) When the buyer is comfortable with, and willing to accept the associated risk.
What happens if you don't have this contingency & can't get financing? 1) You find another way to fund the purchase, or 2) You back out of the contract and lose your deposit.
What happens if you do have this contingency & can't get financing? You are able to cancel the contract and walk away, taking your deposit with you.
This contingency, which defaults in the purchase contract to 17 days, protects the buyer in the event that the appraisal comes in for less than the agreed upon purchase price.
When is it appropriate? 1) When the purchase price exceeds comparable sales in the area and isn't supported by the current market. 2) When the buyer's downpayment is less than 20%, 3) When the buyer doesn't have the funds to make up the difference in value out of their own pocket.
When can it be waived? 1) When multiple recent comparable sales clearly support the purchase price, 2) When the buyer has enough additional funds to pay the difference in value, should the property appraise for less than the purchase price, 3) When the buyer is comfortable with, and willing to accept the associated risks.
What happens if you don't have this contingency & the property appraises for less than the purchase price? 1) You must come up with additional money to make up the difference between the appraisal amount and purchase price, or 2) You back out of the contract and lose your deposit.
What happens if you do have this contingency & the property appraises for less than the purchase price? 1) You are able to cancel the contract and do not lose your deposit, or 2) You can try to renegotiate the purchase price with the sellers to the appraised value and proceed with your purchase.
Inspections & Investigation Contingency
This contingency, which defaults in the purchase contract to 17 days, allows the buyer a period of time to investigate the property to their satisfaction. This is the time period a buyer would have any and all inspections performed, bids/estimates provided, and gain as much knowledge about the property as they want/need to feel comfortable with the property's condition.
When is it appropriate? Whenever the buyer would like to have more information on the condition of the property than was provided by the seller.
When can it be waived? 1) When the seller has provided recent inspection reports performed by qualified professionals, demonstrating the property is in a condition acceptable to the buyer, 2) When the buyer willing to accept any unknown conditions of the property, 3) When the buyer is comfortable with, and willing to accept the associated risks.
What happens if you don't have this contingency and you later discover defects to the property? You deal with the defects out of your pocket (there are caveats regarding defects which were known to the seller and not disclosed, but that's an other post entirely).
What happens if you do have this contingency and you discover defects to the property during your contingency period? You can negotiate with the seller for a credit, or a reduction in the purchase price for property defects (but you cannot renegotiate for "upgrades"), if the seller is unwilling to negotiate to a number that is agreeable to you, you can decide if you're willing to accept the property in its known condition ("as-is"), or you can cancel the contract and walk away with your deposit.
There is a section of the purchase contract which both the buyer & seller initial to agree to specifically regarding liquidated damages. This paragraph states that if the buyer backs out of the contract for any non-contractual reason, the seller has the right to keep the buyer's deposit, up to 3% of the purchase price, as liquidated damages. It's important to note that this is actually a protection to the buyer, as this paragraph limits the amount the seller can claim in damages to 3% of the purchase price. This is not meant to be a punitive action toward a buyer; sellers must prove that they were damaged by the buyers backing out of a contract. This is accomplished through mediation, and subsequently binding arbitration, if necessary.
As I mentioned at the beginning, there are many other ways a buyer (or seller) can build in contingencies specific to their situation. If you have a question about anything in this post, or the best way to protect yourself (and get your offer accepted), post it in the comments, or email me directly.