Five Contingency Clauses that Protect Buyers in California

In a market as hot as this year’s housing market, sellers are at an incredible advantage over buyers. Buying a house in either the greater Los Angeles area or the San Francisco Bay Area is especially difficult right now. According to Annie Vainshtein and Susie Neilson in their June 2021 article for the San Francisco Chronicle, “about 62% of homes in the Bay Area sold for above listing price in the first quarter of 2021.” This is up about fifteen percent over the same time last year and is “roughly twice the national rate.” Southern California homebuyers are in a similar situation to their Bay Area neighbors. In a recent article for The LA Times, Jack Flemming writes that “within L.A. city limits, more than half the homes sold in March [2021] fetched more than the listing price.” Because competition for housing is so fierce across the country, buyers are scrambling to make themselves -- and their offers -- more attractive to sellers. This could mean everything from writing the homeowner a personalized letter to waiving property inspections. While the former is a lovely, low cost touch, the latter can be dangerous. Unfortunately, both home and land buyers who choose to waive contingencies face immense risk -- from unforeseen costs to legal restrictions. Follow below to learn about five contingency clauses that protect buyers. 

What Is a Contingency Clause?

Contingency clauses are often included in contracts for home and land purchases. They typically protect the buyer from fraud and other risks by preventing the sale from moving forward unless certain standards are met. Jean Folger explains in her article “Contingency Clauses in Home Purchase Contracts” for Investopedia. Folger writes that a contingency clause essentially “gives parties the right to back out of the contract under certain circumstances that must be negotiated between the buyer and seller.” Real estate contingencies usually include “details such as the time frame (e.g. “the buyer has 14 days to inspect the property”) and specific terms (e.g. “the buyer has 21 days to secure a 30-year conventional loan for 80% of the purchase price at an interest rate no higher than 4.5%”).” 

Rules for Contingency Clauses in Contracts

Depending on the state and locality, specific legal wording might be required within the contract so “all parties understand the terms” and such terms stand up in court. If conditions laid out in the contingency clauses of a contract are not met, “the contract becomes null and void, and one party (most often the buyer) can back out without legal consequences.” On the other hand, if all conditions of the contingency clauses are met, “the contract is legally enforceable, and a party would be in breach of contract if they decided to back out.” 

There are a number of rules involved in creating active, binding contingency clauses in real estate contracts. In his article “Investor’s Guide To The Real Estate Contingency Contract” for Fortune Builders, Paul Esajian elaborates. Esajian writes that contingencies are conditional, must be based on specific events, need deadlines and should be legally binding.

‍

Common Real Estate Contingency Clauses for Buyers in California

The most common real estate contingencies include inspection contingencies, appraisal contingencies, feasibility contingencies and mortgage or financing contingencies. These differ in scope and application based on the type of property and could be influenced by local laws and regulations. For instance, the state of California regulates the timeline surrounding real estate contingencies. In her article “How Does the Contingency Removal Form Work in California Real Estate?” for Homelight, Christine Bartsch writes that “real estate deals across the US include contingencies.” However, “California is the only state where you need to complete a contingency removal form in order to lift the contingency restraints so that the sale can move forward and close.” 

When considering the purchase of land or a developed property in California, potential buyers should know their rights. In our recent article “Steps to Buying Land in Los Angeles to Build a Home,” we noted that most property owners in California must be transparent about their listings. According to Alicia Tasvibi in her article “Selling a California Home: What Are My Disclosure Obligations?” for NOLO, California "requires its residential property sellers to disclose, in writing, details about the property they have on the market.” Buyers in both the greater LA area and the San Francisco Bay Area should explore how local laws might support them throughout the escrow process.

Five Contingency Clauses to Protect You and Your Future Home

#1 Home or Land Inspection Contingency 

Inspection contingencies are perhaps the most important contingencies for buyers considering higher risk properties like those built on hillsides. In her article “Importance of Home Inspection Contingency” for Investopedia, Amy Fontinelle explains. Fontinelle writes that this type of contingency “provides that if a home inspection reveals significant defects, you can back out of your purchase offer, free of penalty, within a specific timeframe.” This is significant because “many lenders won't offer financing on a home without an inspection” and because “home inspections can uncover potentially life-threatening problems” any buyer would want to know about. 

Home inspections will typically cover the exterior, interior and some landscaping elements of the house and property. Land inspections might not include perc, environmental and soil testing. In the case that such tests are not included, potential buyers should include an additional feasibility contingency clause. Buyers should check with real estate attorneys whenever they are unsure about the proper wording for a clause. During this period of inspection, potential buyers should also conduct their own research. According to Carren Jao in an article for The LA Times, buyers can “contact the L.A. Department of Building and Safety to request public records on a home’s past problems.”

Consequences of Waiving an Inspection Contingency 

Unfortunately, the competitive housing market has created a climate in which buyers feel pressured to release contingencies in order to make themselves more competitive. This comes at significant risk. In her article “More Buyers Are Skipping Home Inspections. Tales of Bats, Termites and Asbestos Should Make You Think Twice” for Money.com, Aly J. Yale elaborates. Yale writes that waiving the inspection contingency “can have grave consequences.” These consequences could include “moving into an asbestos- or termite-ridden home.” In other cases, “it might mean hidden flood damage, mold, mildew, pest infestations or other costly repairs and concerns.” Though they might risk losing the property to a less scrupulous buyer, interested parties should never waive an inspection contingency when considering a property purchase.

#2 Appraisal at Purchase Price Contingency

Next in our list of contingency clauses that protect buyers is the appraisal contingency. For those unfamiliar with the concept, Dock David Treece explains in his article “What Is An Appraisal Contingency?” for Forbes. Treece writes that “an appraisal contingency clause is a provision included in purchase contracts that allows homebuyers to back out of their contract if a home is appraised for less than the purchase price included in the contract.” According to Treece, buyers might include an appraisal contingency in their contract if they are “using financing to buy a house or are buying homes in areas where prices are volatile.” The reason why appraisal contingencies are significant is because “most lenders aren’t allowed to lend more against a property than it’s worth.” As such, if an appraisal value is less than the listed value of a home or lot and both parties have agreed to an appraisal contingency, the seller must match the appraisal price or default on the contract. 

‍

‍

Appraisal Contingencies Protect Earnest Money Deposits 

Not only does an appraisal contingency allow the buyer to back out of his or her contract, but it also allows the buyer to retrieve any money already deposited. In her article “What Is An Appraisal Contingency?” for Rocket Mortgage, Victoria Araj writes that an appraisal contingency allows the buyer to recall their earnest money deposit. According to Araj, the earnest money deposit “is a small percentage of your down payment that you put into a neutral account that tells the seller you’re serious about buying a home.” 

This deposit is debited towards “your down payment if the seller accepts your offer.” However, if the seller rejects a buyer’s offer or fails to match the appraisal value of the home, the buyer gets their money back. Buyers in competitive markets should keep in mind that cash offers typically do not require appraisals and can close without contingencies.

#3 Permitting or Feasibility Contingency

The third contingency in this list of contingencies that protect land and home buyers is the permitting or feasibility contingency. This contingency applies to vacant or partially developed lots more so than it does to fully developed properties. In her article “Clauses to Put in a Contract to Buy Land” for SF Gate, Meribeth Phipps explains what a feasibility clause is and why to add one in your purchase contract. Phipps writes that “most buyers of land have some idea what type of structure they plan to build and how much it will cost.” However, information about whether a lot can support the type or number of structures a buyer plans to erect might not be public. 

As such, a potential buyer might wish to include a feasibility contingency in their contract. According to Phipps, a feasibility survey “should be conducted to factor-in the prices of city permit fees, utility hookup costs, septic permit fees, the cost of installing a well, or any other additional fees.” If such costs “are acceptable for the buyer, [the feasibility] clause allows him to back out of the contract without harm.” During this stage, potential buyers should seek out information about restrictive covenants.

#4 Survey or Subdivision Contingency

During this stage, potential buyers should seek out information about restrictive covenants. It is possible that the property a buyer is interested in has never been surveyed -- particularly if it is an undeveloped lot. In his article “Eyeing a rural property that needs a survey? Write a contingency into contract” for The Chicago Tribune, Benny L. Kass writes that land surveys are essential when purchasing rural property. According to Kass, “if a buyer plans to purchase a rural property that needs to be surveyed, he or she can include a contingency in the contract stating that if the property has less acreage than the seller stated, the contract can be terminated.” These surveys should also include information about easements and other restrictions. 

Restrictive Covenants Impact Development and Other Use

Understanding restrictive covenants ensures that the buyer can use the property as he or she wishes without fear of legal reprisal. Janet Wickell explains in her article “How Restrictive Covenants Affect Land Use” for The Balance. Restrictions apply to both built and undeveloped property -- albeit in different ways. For instance, writes Wickell, restrictive covenants address “setbacks, easements, fees for road maintenance or amenities [and] regulations dealing with in-home businesses and home rentals.”

They also address “rules that limit tree-cutting, clauses that dictate what type of fencing can be used or that forbid fencing [and] clauses to reduce clutter on lots, such as prohibiting owners from storing certain types of vehicles near their homes.” When buyers must conduct their own “research to find out about a property's restrictive covenants” before closing, they should “consider inserting a contingency clause” to protect their interests.”

‍

#5 Financing Contingency or Mortgage Contingency

Lastly, potential buyers should consider including a financing contingency or mortgage contingency in their purchase contracts -- regardless of whether they plan to purchase a lot or a home. Financing contingencies -- also called mortgage contingencies -- protect the buyer from bearing the financial brunt of a purchase if they are denied a bank loan. The Than Merrill article “Does Your Next Deal Need A Financing Contingency?” explains why financial contingencies are important for buyers. 

This post notes that financing contingencies prevent “a deal from moving forward if predetermined financial criteria aren’t met.” According to the article, this type of contingency “acts as a buffer; one that gives buyers an appropriate amount of time to find the funding they need.” Most significantly, a financial contingency “will protect the buyer from having to move forward with a deal if they can’t secure funds,” meaning that the “buyer won’t be penalized for backing out of the deal.”

‍

‍

Added Buyer Benefits of a Mortgage Contingency 

In his article “What Is A Mortgage Contingency?” for Forbes, Dock David Treece notes that mortgage contingencies not only protect buyers from a contract they cannot fulfill without a loan. They can also offer additional protections. First, properly written mortgage contingencies can help potential buyers “get their earnest money back” if the deal falls through. Second, mortgage contingencies can “include a section if you need to sell another property in order to qualify for a loan.” 

Homeowners who are relying on the sale of their current home or property to fund the purchase of their next property are well-served by such a contingency. In such a case, writes Treece, “your purchase would be contingent on two things: selling your home and  getting financing” and a seller would not be able to penalize you for defaulting if one falls through.

What to Know About Releasing Contingency Clauses for Buying Land in California

In California, buyers must release contingencies in order to proceed with a real estate purchase contract before a specific period of time has expired. A contingency removal form must be filed for each and every contingency outlined in a contract -- whether there is only a single contingency or there are three or four. Christine Bartsch explains in her article “How Does the Contingency Removal Form Work in California Real Estate?” for Homelight. Bartsch writes that California “has some of the most complex real estate laws in the country.” She explains that “in most cases, these forms are used to remove a buyer’s contingencies—so it’s the buyer’s responsibility to complete the form.”

Contingency Release for Buyers and Sellers

Elizabeth Weintraub explains the ways in which California sellers and buyers must behave in order to release contingencies in her article “Releasing Homebuyer Contingencies” for The Balance. According to Weintraub, “purchase contracts give buyers 17 days to release an appraisal contingency in California, but this is the default option if nothing else is selected.” If specified in a contract, this “time frame can be extended or shortened by the terms of the contract.” However, if the agreed upon timeframe has expired and “the buyer hasn't signed a release of contingencies,” the seller of a property can cancel their contract. Unlike other states in the US, “it's up to the seller in California to demand that the buyer perform if the buyer doesn't sign a release of contingencies within the specified time period.” 

How Element Homes Can Help Buyers with Contingency Clauses

Contingency clauses are designed to protect the interests of both potential homebuyers and potential landowners. For those interested in purchasing land in California, contingency clauses can protect buyers from overpaying or for taking out an inappropriate loan. They can also protect landowners from purchasing land that cannot be subdivided or developed in the ways a buyer would prefer. Element Homes’ practiced design-build team is well-versed in local building codes, permitting requirements and legal restrictions. 

As such, Element Homes can aid potential buyers in creating legal contracts that best protect their interests when purchasing land for their future homes. To learn more about buying land in Los Angeles, read our post “Subdividing Land in Los Angeles to Build a Home.” For more about subdividing land in California, read our post “Subdividing Land in California.” If you are ready to build, book a consultation with the Element Homes team today.

‍

‍