Contingencies Are the Buyer's Friend
A significant portion of the purchase contract consists of clauses relating to conditions, or contingencies. These are items that must be satisfied within certain time frames in order for the sale to go through.
Think of contingencies as the legal loopholes that allow you to back out of the contract under certain circumstances. They serve as protection and apply a practical brake to the emotional rush that often drives a home purchase.
Keeping track of due dates
A useful tool during the weeks leading up to closing is a calendar or schedule that reminds you of dates by which certain tasks must be completed. Contingency clauses also specify when and how notice of cancellation must be given and received. Your real estate agent and the escrow company handling the transaction should be staying on top of this schedule, but it will help if you keep an eye on it as well. The others are juggling many schedules; this one is your baby.
Contingencies are a double-edged sword. Some of them are designed to protect you from major disaster, letting you cancel the contract without penalty. By the same token, of course, the seller is allowed to rescind the contract if you don't meet your obligations.
Many states now require sellers to give buyers a completed disclosure form within a few days of both parties having signed the purchase contract. Often the form contains a statement that the seller knows that the buyer is relying on the form's contents. Some real estate companies require seller disclosures, and agents can be held legally responsible for not disclosing defects to buyers.
Even where disclosure is voluntary and even if the sale is deemed “as-is,” sellers must disclose all material problems and defects that would affect the value of the home and the buyer's decision to purchase.
The disclosure statement covers everything from roofs, appliances, plumbing and termites to environmental hazards (abandoned oil or septic tanks, for example) and zoning changes or assessments that might affect the cost of living. If the property is in an earthquake hazard zone, flood zone or other area where government regulations apply special building restrictions or requirements, that must be disclosed as well.
The seller must declare whether he or she has knowledge of any of these problems or others such as past water or fire damage, even if repaired.
If you have not received a disclosure form by the deadline, you have the right to cancel the contract and get your deposit back. Once you receive the disclosure form, you have a limited time to decide what you want to do, including rescinding your offer.
The financing contingency
Perhaps the most essential contingency clause for most buyers is financing. This makes the offer conditional upon your getting a mortgage for the amount and at the terms you specified in the offer, including the interest rate, whether the rate is fixed or adjustable, the duration of the loan and the amount of the monthly mortgage payment. If you're assuming the seller's existing mortgage or the seller is “carrying back” a second deed of trust, those terms would be spelled out as well.
Having your financing pre-approved before you make an offer gives you an enormous step up, but other necessary items in the loan process — appraisal and homeowner's insurance — can cause the deal to fall apart.
How appraisals affect you
Your mortgage lender will require an appraisal of the property before issuing the loan. Most lenders require that the loan-to-value ratio be no greater than 80 percent. That is, the bank usually will not lend more than 80 percent of the appraised value. If the appraisal comes in lower than the purchase price you've agreed to, you may suddenly find yourself several thousand dollars short of needed cash at closing.
If the purchase price is in line with CMA (comparative market analysis) numbers, you could ask the mortgage lender to have another appraisal done or to override the appraisal value and issue the original amount you requested. If that doesn't work, a properly written appraisal contingency clause would allow you to renegotiate the purchase price so that it matches the appraisal, or to cancel the offer and get your deposit back.
To protect their investment, lenders require you to carry fire and hazard insurance. If you don't have insurance in place before closing, the lender won't come through with your loan. If you don't purchase your own policy, you will have to pay for the more expensive one the lender will take out for you. Failure to pay insurance premiums will result in foreclosure.
In certain parts of the country, lenders will require additional coverage for events — hurricane, flood, earthquake — excluded from ordinary policies. If your house is in a labeled flood zone, you will need to take out special flood insurance. This is sometimes available from the federal government's National Flood Insurance Program. Earthquake insurance is sometimes difficult to come by, so if you need it and can't find it, contact your state insurance commission.
To avoid last-minute problems, apply for homeowner's insurance as soon as the purchase contract is signed. Get price quotes from at least three companies and have the policy delivered to the escrow company or closing agent a few days before the scheduled close.
Make the purchase contingent upon a satisfactory Comprehensive Loss Underwriting Exchange (CLUE) report, or upon your being able to obtain affordable insurance. Your agent may need to attach a rider or an addendum to the purchase contract.
Don't be CLUE-less
Insurance companies have lately been running the equivalent of credit reports on properties to see how often these homes have been involved in insurance claims. If the home you wish to buy is deemed a bad insurance risk, you may be unable to get insurance at all or have to pay much higher rates.
One way to guard against this situation is to ask the seller for a CLUE home seller's disclosure report. CLUE, or Comprehensive Loss Underwriting Exchange, is a national database containing more than 40 million personal property insurance claims. The CLUE report for the house you wish to purchase will show all claims reported over a five-year period. This will show the date, type of loss and amount paid for claims such as water damage, mold and fires.
Only the homeowner or the insurance company can request the CLUE report, so you need to request it from the seller.
Sale of buyer's property
This is a contingency some buyers might feel safe in waiving if they've got a buyer for their other property. However, if you need the proceeds from this sale in order to close on your new home and the other sale has not yet closed, you'd be wise to leave the contingency in place. Otherwise, you could lose your deposit if your other deal falls through and you can't close on the new house. But recognize that this makes your offer much weaker to the seller.
A clause making the purchase contingent on a satisfactory survey ensures that you know whether any structures of your new home encroach on your neighbor's property or vice versa. Your mortgage lender may want a valid survey as well. The question of who pays for it may be negotiated between you and the seller. If you're thinking of installing a major improvement such as a swimming pool or replacing a chain link fence with a beautiful rock wall, you will definitely want to know precisely where your property lines are. You will also want the seller to obtain written statements from any neighbors with whom there are encroachments that have previously been accepted.
Clear title and other claims
The title insurance company is charged with researching the title on your property to determine that you will have clear ownership and that there are no outstanding claims against the property. The most common type of lien against real estate is a mortgage, but liens for unpaid work performed on the property also occur. If you are purchasing a home from an estate, make sure that the estate has paid all estate taxes. If the estate defaults, the IRS can and will come after the new owner (that would be you) for delinquent estate taxes; the estate tax lien lasts 10 years. However, if you have title insurance, the insurance company will have to foot that bill.
Buyer's tip: Pay attention to the "exclusions" in your title insurance policy. They might make you wonder what the title insurance policy does cover. In general, it covers anything that is legally recorded and excludes anything that is "on the ground" (e.g., a fence that crosses the property boundary). It's the latter that could get you in trouble later on. If you see anything that makes you wonder about the property lines, ask for a survey paid for by the seller.
If you're buying a condo, you will at some point be handed a thick packet of documents from the condo association detailing the condo rules and regulations, covenants and financial documents. Your purchase can be contingent on your approval of these documents.
You can include a clause specifying that the purchase contract be subject to the review and approval of your attorney or subject to the approval of your spouse after he or she has had a chance to see the house in person. Review contingencies are often used to give you an “out” if you suddenly realize you've made a mistake. In some cases, you can also include a "neighborhood review" as a contingency, meaning that you have a certain amount of time to review the neighborhood to make certain it's where you want to live. However, given that most sellers are looking for the “cleanest” contracts, it's probably wise to thoroughly research a neighborhood prior to making an offer on a home.