Demystifying the Home Purchase Contract: Understand the Nuances
The process of purchasing a 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.
Below, I have listed out some of the important items you should be aware of, that require you to make decisions as a home buyer in entering into a purchase contract.
Loan or Financing Contingency
Loan contingency is the period of time the seller is giving you to obtain full, formal loan approval. It is important to include a financing contingency in your offer, as it makes the transaction dependent on you receiving the mortgage you’ve applied for. It specifies your cancellation rights if you are unable to obtain financing.
This contingency is typically between 10 and 21 days depending on what has been negotiated in the contract. The earnest money deposit you make at the time the offer is accepted will be put in jeopardy once the 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 could lose your earnest money deposit and not have the failure of obtaining loan approval to lean on as an excuse. Written pre-approval for your mortgage will help to eliminate problems in this area.
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, 45 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 period to complete all aspects of due diligence. This may especially be true if you are buying a “not-built-yet” house from a builder.
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. Once your home inspection contingency has expired, you no longer have the leverage to go back and renegotiate with the seller to resolve any issues revealed by the home inspection. If there are material defects, you and your real estate agent should renegotiate either a reduction in the purchase price to offset the cost of any necessary repairs or having the seller make the repairs prior to the close of the transaction. Buyers with limited cash reserves should most likely negotiate to have the repairs made prior to closing.
A termite inspection may be required by the mortgage lender if it is listed in the purchase contract. The lender may also require an inspection if the appraisal states there is evidence of termite damage. On FHA loans inspection is required only under the following circumstances: when there is evidence of active infestation, if mandated by the state or local jurisdiction, if customary to the area, or at the lender’s discretion.
If termites are present it is up to both parties to determine who will be responsible for the remedy of the problem. When you negotiate your contract make sure 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 agents will negotiate a – rent back period. This means when the transaction 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 closing costs, origination points and/or pre-paid items (interest, hazard insurance, tax escrows) 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.
The typical seller contribution is from 1% to 3% of the purchase price. Seller contributions may sometimes 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 the transaction to accommodate repairs to the property.