The Nuances of Your Contract
The process of purchasing your home is often much more complex than the average individual expects it to be. Items involved in your purchase contract can have a significant impact not only on the success of your purchase transaction, but on your stress level as well. We have listed out some of the important items you should be aware of, that require you to make decisions as a buyer entering into a purchase contract.
Loan contingency is the period of time the seller is giving you to obtain full, formal loan approval. This contingency is typically between 15 and 21 days depending on what you and your Real Estate Agent have negotiated on your behalf in the contract. The earnest money deposit that you put into an escrow account at the time the offer is accepted will be put in jeopardy once that contingency for the loan has expired. In fact, pursuant to the terms of the contract, if the loan contingency has expired and you fail to close the purchase transaction, you can lose your earnest money deposit and not have the failure of obtaining loan approval to lean on as an excuse.
For this reason, it is extremely important to make sure you are not agreeing to a loan contingency in an offer negotiation unless you are absolutely certain you will be buying the home and you know you do not need to depend on financing approval to close the transaction. Formal pre-approval will help to eliminate any problems in this area.
Seeking complete pre-approval for financing prior to making an offer on a property is a sound strategy that can help you get the best deal possible, especially if you plan to make a minimal down payment. The seller is often leery of the stability and reliability of the buyer if the buyer is only capable of making a down payment of 10% or less. This can cause the buyer to lose a significant amount of negotiating ability, by being perceived as a weak buyer rather than a strong one. This is why it is very important to get full loan approval in advance, and provide a written confirmation of that loan approval when an offer is made on a property. This shows it is a done deal, and you are perceived to be a cash buyer.
The contract period is the period of time in which all due diligence must be completed, including obtaining loan approval, property appraisal, home inspection reports, termite inspection, etc. Give yourself enough time for all due diligence to be completed for this very important purchase you are about to make. Typically, purchase contracts are drawn up for a period of 30 days, 45 days or 60 days. However, it is really not uncommon for a purchase contract to be written with terms in excess of 60 days if the parties involved need that long of a grace period to complete all aspects of due diligence.
Home Inspection Contingency
As part of the negotiation in your purchase contract you and the seller will mutually agree upon the amount of time needed to complete all the home inspection procedures that are required. Utilizing an outside third party service to complete these inspections is highly recommended.
You will be provided with a report by the home inspection company that you should review very thoroughly to make sure there are no material defects in the property that you were not aware of, and which could subsequently have an impact on the value of the property. If there are material defects, you and your Real Estate Agent should go back to the negotiating table and discuss an ample reduction in the purchase price to offset the cost of any necessary repairs. Once your home inspection contingency has expired, you no longer have the leverage to go back and renegotiate the purchase price to resolve any issues revealed by the home inspection.
Termite inspection is required by the lender if it is listed in the purchase contract. One common fallacy in the home buying process is that the lender always requires termite inspection, regardless of what the contract states. This is not true. A lender only requires it if both the buyer and seller mutually agree to termite inspection and it is included in the terms of the contract. From there, it is up to both parties to determine who will be responsible for the remedy of the problem, if in fact termites are present. Most commonly, the solution is that Section 1 termite work will be covered by the seller, and Section 2 termite work to be covered by the buyer. Make sure when you negotiate your contract you state up front whether you want the property checked for termites.
Seller Rent Back
It is often the case that when the buyer and seller are unable to agree upon a specified closing date for the transaction, the Real Estate Agent involved will negotiate a “rent back” period. This means the transaction technically closes, the loan funds and ownership of the property is transferred into the buyer’s name, but the buyer does not take occupancy of the property until several days later. In this scenario, the buyer sets up a rental agreement, in which the property is leased back to the seller.
An important footnote to this somewhat common strategy is to make sure the seller is not occupying the property in a lease agreement for more than 30 days after the close of the purchase transaction. This would constitute a non-owner occupied purchase in the lender’s eyes, and would cause the terms of the loan to change radically.
Depending on the seller’s eagerness to close the transaction, the seller of a property will often become aggressive and offer to pay some or all of the non-recurring closing costs and/or origination points associated with the purchase on the buyer’s behalf. This common strategy can be very beneficial to the buyer, particularly if the buyer is short on funds to close. It can also be the vehicle that effectively drives the interest rate down and provides the buyer with a more affordable monthly payment.
Note that there are limitations on how much the seller is permitted to contribute, depending on the loan-to-value ratio. The typical limitation stipulated by the lender is that the seller contributes no more than 6% of the purchase price. Seller contributions MUST BE isolated to non-recurring closing costs and/or origination points only. The lender will not permit the seller to contribute funds back to the buyer after the close of escrow to accommodate repairs to the property. Items such as roof leakage, new carpet, new paint, etc. cannot be covered by any seller contribution clause.