So, when you have to move, it’s a hell whole lot easier to break or ride out a lease than it is get out of a deed (or sub-lease, if you own a co-op) even if the mortgage has been paid off or you never had one, to begin with. This is just a fact as it is.
But it becomes even more complicated when your next home isn’t a rental, but another purchase. Most people don’t have hundreds of thousands, or millions, laying around like celebrities do to just easily buy up multiple properties like you’re buying several new dresses at H&M, then worry about selling the old dresses on eBay. If you own your home and are looking into buying your next residence, there’s a very strong chance you’re going to have to do a home sale contingency.
You’re in the tough situation of needing to swap out one huge, expensive asset for another and it’s more common than you think. Here’s what you need to know about having to do a home sale contingency as a buyer, and what could possibly come up if you’re selling your home but your buyer has to do a home sale contingency.
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What is a Home Sale Contingency?
A home sale contingency is a clause often included in real estate sales contracts where the transaction depends on the buyer successfully selling their home. If they can’t sell their home by a specified date, then the contract terminates. If the home sells by that date, the contract moves forward. Usually, some earnest money (such as 5% of the down payment) is put in escrow to show both financial capability and intent to proceed with the sale.
If you or the person buying your home is a first-time homebuyer who rented all their life prior to making an offer, you won’t have to worry about this. But when you’ve got a deed and mortgage instead of a lease to move on from, and you’re buying your next home, there’s a strong chance you’re going to have to do this on a home sale contingency.
According to the National Association of Realtors, 76% of all the closed home sales reported to them in January 2018 had some kind of buyer contingency. The most common was having a home inspection done (58%) along with obtaining financing and appraisal, but only 5% of these transactions were contingent on the buyer selling their current home.
There could be several factors behind those numbers, such as the buyer owning their home but choosing to rent it out instead of selling. First-time homebuyers declined slightly in 2019, representing just 33% of home sales, although it is highly likely they were subjected to other contingencies like financing and appraisals. Buyers who had large sums of money to purchase a new home, such as an inheritance or divorce settlement, have the luxury of being able to worry about selling their original home later. Most people can’t do this so home sale contingencies aren’t this totally rare phenomenon, but they can make both the buyer’s and seller’s lives more difficult.
If you’re selling your home and attract a few potential buyers, let’s say the one with the best financial situation and thus most likely to successfully close is already a homeowner but needs a home sale contingency. They could be high-income with banks just clamoring to give them a mortgage, but they could be living in an area where homes for sale only get tumbleweeds at open houses. Or they’re in a perpetually hot market like NYC, but the buyer’s co-op board decides now is a FANTASTIC time to make current and prospect owners’ lives miserable by letting the applications pile up since the board won’t meet all summer long.
Not all housing markets are equal. So, there are two types of home sale contingencies for this reason: sale and settlement, or just settlement.
Sale and Settlement Contingency vs. Settlement-Only Contingency
Basically, the difference between a sale and settlement contingency and a settlement-only contingency boils down to whether the person buying your home has already found a buyer for theirs or not.
A sale and settlement contingency means that the home sale contract hinges on the buyer selling and settling their current home because they don’t have any offers on the home yet and thus did not accept one. This type of contingency allows the person selling them to home to still show it to other buyers, in case they find one who doesn’t require a home sale contingency at all.
Typically, the seller can remove the sale and settlement contingency within 24-48 hours if they get another offer from such a buyer. If the original buyer really needs that home sale contingency, the contract is terminated and the seller is free to accept other offers from buyers who don’t need to sell their homes first. The earnest money gets refunded, and the buyer sighs and goes back to the drawing board, losing both the time and possibly legal fees.
A settlement-only contingency is meant for when the buyer is already under contract with someone to take their existing home off their hands, and a settlement date reasonably estimated. Of course, this rule does not apply to New York co-ops. You’re going to wait and wait and wait and wait and wait and wait and gather a bunch of incredibly stupid paperwork, then wait and wait and wait and wait and wait some more so our home sale contingency clauses probably have more leeway than your typical American home sale.
The purpose of the settlement-only contingency is to protect the buyer in case you rescind the sale for any other reason not covered in your sale contract. The only way a contract with a settlement-only contingency will get terminated would be if that buyer’s buyer cannot close (e.g. they lose their job or get into an accident, or co-op board hell ensues) by the specified date.
The Ultimate Risks of Buying and Selling on Contingency
From the buyer side of things, you’re already going to have a really difficult time getting out of a place you own. Most people can’t afford to maintain the mortgage, real estate taxes, utilities, and upkeep for two different homes, plus all of the incredibly huge cash outlays inherent to looking for a new home like inspections, mortgage and co-op/condo board application fees, appraisals, legal fees, and sundry. It easily is thousands of dollars and unlike your earnest money deposit, it doesn’t go back to you if the seller winds up going with somebody else who doesn’t need to do a home sale contingency.
Home sale contingencies let you exit one home and enter another in one transaction. But while they aren’t this rare and exotic situation, they can end up working against you in a really tight market. Because the seller is also taking a risk on you being unable to complete the transaction, you’re also going to have to make a higher offer price than someone buying sans contingency.
From the seller’s perspective, yes, it’s a gigantic risk for the reasons I just mentioned. The odds are in your favor in areas that have real estate markets tighter than spandex such as New York, Boston, and the Bay Area, where people are less likely to do a contingency because they can afford to temporarily maintain two homes or are coming from rentals. Because of the aforementioned godawful co-ops, they’re ultimate proof that the buyer having a sales contract is zero guarantees that the sale will actually close. Even if co-ops aren’t a thing where you live, shit still happens. When you have to list your home as being under contract as well, seeing that it’s already under contract will detract potential buyers who don’t require a contingency.
Before committing to a buyer who needs a home sale contingency, the seller should ask a broker for help determining if the home is already on the market and listed at the right price relative to the condition, location, and comparable homes in the area. Check on how long it takes the average home in the buyer’s area to sell as well, if it’s well past 90 days then you may want to pass over this buyer because there’s a strong chance that the settlement date– if it happens at all– will pass the date specified in the contract.
All in all, home sale contingencies present a lot of risk to buyers and sellers alike but are a necessary evil since most of us aren’t millionaires who can just seamlessly buy a new place and worry about selling the old one later. But depending on your situation, and if you can handle a second set of moving expenses, you might want to look into moving to a temporary rental than buying a new home. Home sale contingency could be a viable option if it’s a buyers’ market where you are, but if it’s a sellers’ market, going from a temporary rental and back to ownership could be worth the purchase price savings and peace of mind alone.
Unless you’re trying to sell or buy a co-op. You’re never going to have peace of mind there.