Making an offer on a home can feel like it’s happening so quickly that you hardly have any time to think. Take a moment to make sure that you (and anyone else you’re purchasing with) understand all the important parts of the offer contract, especially those reasons for which you’re allowed to back out of the offer. These are called “contingencies,” and they’re put in place to protect your earnest money.
This is an abridged excerpt from Chapter 10 of First-Time Home Buyer: The Complete Playbook to Avoiding Rookie Mistakes by Scott Trench and Mindy Jensen. To get more first-time home buyer tips, find the book in the BiggerPockets Bookstore!
This is a fancy word for “conditions.” I’ll pay you for the house on the contingency that all goes well with the inspection. I’ll pay you $100,000 on the contingency that the property appraises for at least $100,000. If the property appraises for only $99,999, I don’t have to continue with the purchase.
Remember when your mom told you that no one wins with an ultimatum? Well, this is the only situation in which your mom is wrong. Every contingency is an ultimatum, and these ultimatums protect you (and your earnest money) in the event that anything goes wrong during the buying process. If anything goes south, the contingencies in your contract allow you to back out of the purchase without losing your earnest money.
Related: Earnest Money: What It Is, Why It’s Important — and How to Protect Your Deposit
Along with signing your offer contract, you will be submitting an earnest-money check. This shows the seller you are serious about your offer and you’re willing to put your money where your mouth is. The amount of earnest money will be dictated by the listing, but this number is the minimum amount required. If you’re up against competition, you can always make your offer stronger by increasing the amount of earnest money.
Fortunately, your earnest money payment doesn’t disappear. It’s credited toward your down payment at closing. For example, if you write a $10,000 check for earnest money, that will then roll over to cover some of your down payment and closing costs. If your down payment and closing costs happen to be less than that amount, you will get a refund after the house is yours.
Unfortunately, earnest money can be forfeited to the seller if you do not comply with the terms of the contract or if you miss a deadline. Your agent should help keep you on schedule with your dates and deadlines, but you want to make sure you’re on top of them as well. Enter everything into your calendar and set alerts for the day before to make sure you stay on top of all you need to do. Though your agent should help remind you, you are the one who will be hurt the most if you miss a deadline.
This depends entirely on the “contingencies” section of your contract. Typically, as long as all deadlines are met, the buyer is allowed to back out of a deal for five common contingencies: loan approval, home sale, home inspection, appraisal, and title insurance.
If you’re currently living in a house that you must sell before buying another, that would be a home sale contingency. Also, no big surprise that your lender must be able to underwrite and approve your loan before you can buy the house. If either of these fall through, there’s typically an escape hatch built into the contract with which you can keep your earnest money.
If you hire a property inspector and they find that the house is falling apart, you should be able to back out and keep your earnest money. The extent to which you can do this depends on your contract and whether you included an inspection contingency.
With an inspection contingency, you can make it clear to the seller that you’re not going to nitpick over everything in order to negotiate further on price. Essentially, you aren’t going to ask for repairs on the “little things” in the inspection report.
If you’re only getting an inspection to check the major items—like the HVAC system, roof, structural integrity, and radon levels—make sure to note this in your offer and specify what needs to pass inspection. This contingency is especially helpful if you’re buying an old, ugly home to force appreciation. You probably don’t care if the ancient shag carpet has stains on it when you’re planning on ripping it all out anyway.
A third-party professional will perform an appraisal to make sure the home’s value and purchase price aren’t miles apart. The appraiser will look at comparable properties that have sold recently—the same properties we told you to look at with your agent to determine a purchase price—and use those comps to determine the home’s value.
Your contract will likely contain an Appraisal Provisions section, which outlines the appraisal process, who pays for it, and what happens in the event that an appraisal comes in under value.
For example, if a buyer offers $410,000 on a home that appraises for $400,000, there are three options. The seller can agree to reduce the price, the buyer can bring the excess $10,000 to the table so the loan amount does not exceed the home’s value, or the buyer can back out of the purchase entirely. They should be able to back out and still keep their earnest money if this has been specified in the contract.
Related: What Is Underwriting? Here’s What to Expect
Put as simply as possible, title specifies who has rights to the property. When you purchase a house, there will be a title transfer in which you are granted ownership of the property and the seller gives up ownership in exchange for selling the house. The title company will take care of this process, and title insurance protects both you and your lender from any defects in the title.
If your new home is on a plot of land that once belonged to Farmer Joe, you would assume that he legally sold that property to whoever built the homes there. However, if he pulled a fast one on the buyer and his great-great-grandson has legal rights to half the land under your house, things could get messy for you down the line.
Similarly, if the previous owner of the home never paid for a $30,000 roof replacement, there might be a lien on the home so the roofer can finally get their hard-earned money. If you overlook this when you buy the home, that $30,000 will become your problem.
Your contract will include a few different title deadlines, during which the seller will provide a copy of their current title and you and your agent can scope it out for anything fishy. There’s also a title objection and title resolution deadline before which you can point out and solve any problems or back out of the offer completely without losing earnest money.
Resolving title problems can be super complex or super easy. A property with title problems might not be covered by title insurance at all, or the insurance policy might exclude that problem—meaning your interest in the property can be lost. Title is complicated, so make sure your contract allows you to back out in case of a title emergency.
If your home sale falls through, all hope isn’t lost. Follow these tips to get a refund on your earnest money—and buy First-Time Home Buyer: The Complete Playbook to Avoiding Rookie Mistakes for more smart home-buying tips.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.