While the housing market has cooled some since I started this post in the Spring, there are still some areas that are moving quickly and aggressively, and this information is still helpful regardless of you being in a multiple offer scenario. Over the course of 6 years and 18 properties purchased (and countless offers made), we’ve caught on to some helpful parts of contracts. Again, keep in mind that I’ve seen real estate contracts in New York, Virginia, and Kentucky; this is not all encompassing or what may work perfectly in your market. This also doesn’t include all parts of a contract since most of them are standard and/or can’t be anything but matter-of-fact (e.g., will the property be owner occupied; is the property subject to a homeowner’s association).
Your contract is going to encompass the basics of the purchase each time. This would be the buyer and seller names, address of the property, offer price, and closing date.
Typically, the buyer’s agent draws up the contract with the information being offered. If the offer is accepted by the seller, the seller signs the contract. If there are negotiations, the buyer’s agent will adjust, have the buyer re-sign, and then submit to the seller for signature. When the buyer makes the offer (which is just filling out the contract and sending it to the seller), the buyer will typically include an expiration date of the offer. This isn’t always enacted, but it’s there as a protection so the buyer isn’t sitting idle for extended periods of time waiting for a seller to make a decision. For example, we had an expiration clause in a contract recently where our offer expired at 8 pm that night, but we knew they weren’t going to review offers until the end of the weekend; we had put it in there as a way to hopefully push the seller to make a decision with just our offer instead of waiting for more offers to roll in. We ended up getting the contract on the house, even though our expiration date had technically expired.
In Virginia, the closing date language says “on or before X date, or a reasonable time thereafter.” In Kentucky, it says “on or before X date,” and if you can’t close by that date, you and the buyer have to process an addendum to the contract with a new closing date. We had a contract, as the seller in Virginia, close 2 months after the date in the contract. We were furious about that. We could have walked away and kept the buyer’s earnest money deposit, but then we’d have to formally list (it was an off market deal) and manage that process along with the home inspection issues that may arise. We also had a contract in Kentucky where our lender messed up and delayed our closing, so we had to sign an addendum to the contract to allow us to close a week late.
EARNEST MONEY DEPOSIT (EMD)
Earnest money, or good faith deposit, is a sum of money you put down to demonstrate your seriousness about buying a home. In most cases, earnest money acts as a deposit on the property you’re looking to buy. You deliver the amount when signing the purchase agreement or the sales contract, and it’s applied to your balance owed at closing.
This is not a requirement, but it’s showing your “good faith” to purchase the property because there’s a penalty to you if you try to walk away from the purchase.
In most cases, you pay the EMD to your realtor’s office and they hold it until closing. In Kentucky, they’re on it right away, asking you to send the check as soon as the contract is signed. In Virginia, I didn’t always send the EMD. The amount is listed in the contract, so if I were to default on the contract as a buyer, I would still owe that amount even though I hadn’t paid it to my realtor’s office.
Typically, you’re looking to put 1% down. On a $90k purchase, we gave an EMD of $900. On a purchase of $438k, we gave an EMD of $5,000 (but there were other factors at play as to why we went higher than 1% on that, which I’ll cover later).
Some items we’ve seen in our contracts are options for the buyer to back out of the contract, or a contingency.
A sale can be subject to financing. If it’s not an all-cash offer, and there will be a loan secured to purchase the property, data can be entered to protect the buyer’s interests. Typically, it’s going to list the years of the loan to be secured (e.g., 30 year conventional), a downpayment amount, and a maximum interest rate. The interest rates hadn’t been fluctuating much, but this would play into things in the past few months. If you tried to purchase a home when the prevailing interest rate was about 4%, and then interest rates rose to 5.5%, it may affect your ability to qualify for the loan or put you outside a comfort zone for your monthly payment amount. For example, on a $250,000 loan at 4%, your monthly payment is about $1200 per month (principal and interest); if the rate raises to 5.5%, your monthly payment becomes $1420 per month.
This information does not lock you into that break down. If the contract says 80%, and you decide to put 25% down based on the rate sheet, the contract isn’t changed nor is it voided.
If the sale is subject to financing, then it has to be subject to the appraisal. This is a lender requirement to protect their interests. There are some caveats to this, but I will cover them later since they’re more advanced. An appraisal will cost the buyer in the realm of $450-600.
If you’re attempting to qualify based on rental property income, the lender may require you to pay for a rental appraisal as well. We’ve seen this cost at an additional $150, but we’ve typically been able to negotiate our way out of that by providing leases and income history.
This is one that I almost always recommend including in your offer. This is your “out” in almost every situation. If you get a home inspection, and it finds anything, you can walk away from the contract and not lose your EMD. If a house is important enough to you (a personal residence that you want regardless of what you find on an inspection report), you may eliminate this contingency, but you’ll typically include it. You can even include that you’ll do a home inspection and decide to not do it.
If the house is being sold as-is, it doesn’t mean you can’t get a home inspection. You can still get the inspection to know whether you want to move forward with the purchase. Being sold as-is just tells the buyer that the seller is not willing to negotiate price or fixing items if the home inspection finds something.
The buyer is responsible for the cost of the home inspection. We’ve paid between $300 and $650 for it. The inspector will take about 2 hours to look through the house, including the roof and mechanical parts behind the scenes. Sometimes the inspector will say “this doesn’t look right, but you need to consult a professional in that trade,” which is usually what happens when it comes to roofing. We have done a home inspection, found too many issues to manage (e.g., stairs built out of code) and walked away from the contract. In that scenario, we don’t lose our EMD, but we did pay about $500 for “nothing” (unless you count all the savings of not throwing money into the house to make it safe and livable).
If you find items on the home inspection that you don’t or can’t fix yourself, and the house isn’t being sold as-is, you can request the seller address them. An addendum to the contract will be filed to identify what the seller agrees to fix, and professional receipts have to be supplied before closing to satisfy the requirement. A seller may say they don’t want to be bothered with coordinating the trades to fix the items and offer financial compensation (e.g., we project the cost of these fixes to be $1000, so we’ll take $1000 off the purchase price).
In the realm of “the contract can say almost anything you want,” here’s an example of an additional term that was in one of our contracts. On this particular house, we should have walked away. The closing process was a nightmare because the seller hadn’t paid the electric bill, so we should have known that them wanting a free pass on inspection items was a red flag.
Virginia has a clause to protect the seller’s ability to walk away from the contract in the event of drastic home inspection repair costs.
Wood Destroying Insects (WDI)
A WDI is basically your termite inspection (may include carpenter bees, ants, etc.). We learned with our very first home purchase that this inspection is pretty useless. You can teach yourself what outward signs to look for regarding termite damage. It’s a visual inspection of what the technician can see. But the damage caused by WDIs is behind the drywall. If there’s signs of WDIs outside the studs of the walls, you’ll see it, and that means you have a big problem. Pay the $35 for a professional to say there are signs of active termites.
Another way we found that the WDI is useless is that we had a major termite problem in our house. We were paying for treatment when we sold the house. The treatments weren’t working and the next step was pulling up all the flooring in the basement and treating under the foundation ($$$). The termite company wrote their report: There is an active infestation of termites that are actively being treated. Technically, true. Productively, not the whole picture.
‘ADVANCED’ CONTRACT OPTIONS
I don’t know that these are necessarily advanced, but they’re less common options when making an offer. Some of them come in handy at opportune times, so it’s helpful to know the options at your disposal.
The seller subsidy is the seller’s contribution to closing costs. It reduces the seller’s bottom line based on the offer amount, and it reduces the amount of money the buyer needs to bring to the settlement table. If a contract offer is $102,000 purchase price with $2,000 seller subsidy, then the seller’s bottom line is $100,000.
There is a limit of how much seller subsidy can be in a contract, which is based on the lender’s requirements and is typically 2% of the purchase price. We have had to adjust the contract to account for this limit before we were aware of it; we kept the seller’s bottom line the same, but adjusted the numbers so that we could maximize the seller subsidy.
In Virginia contracts, there’s a boiler plate section identifying the possibility of seller subsidy. In Kentucky, it has to be written into the additional terms section.
If you’re in a multiple offer scenario, it may be helpful to offer with an escalation clause. This is an option that a prospective buyer may include to raise their offer on a home should the seller receive a higher competing offer. The buyer will include a cap for how high the offer may go. It’s essentially a way for the buyer to compete with other offers, but not necessarily pay top dollar for the house.
Most recently, our offer was $420,000 and we were told there were at least 4 other offers. We added an escalation clause to our offer. We decided to make it a strange number (e.g., increase by $1770 at a time), and we capped it around $450,000. We were basically saying that we were willing to pay up to $450,000 for the house, but we didn’t have to commit to that number by making our offer at $450,000. The highest offer outside of our offer was about $436k, so our escalation of $1770 over highest offer got us the house for about $438k.
Appraisal Gap Clause
As mentioned, a home purchase with financing is going to be subject to an appraisal. With the housing market exploding purchase prices in the last couple of years, houses have been selling for well over list price. This is nice in theory, but that doesn’t mean that a bank is going to agree that your purchase price is “fair market value.” If your contract is for $500,000, but the home values in the area only support $420,000, the bank is not going to give you a loan based on $500,000. Either the seller has to agree to accept the lower purchase price, end the contract and start over with the listing, or the buyer has to agree to pay the difference in value in cash. A gap clause is preemptive attempt to address this difference between the contract price and the potentially lower appraisal price.
If the buyer believes that the area’s home prices will support a purchase price of about $450,000, but they want to make an offer of $500,000, the buyer may include a gap clause of $50,000. This means that the buyer is more attractive to the seller because the seller’s risk of the contract falling through after the appraisal comes back is minimized. This also means that a buyer would have to be able to show the lender that they have the cash to cover the gap clause needed (if needed), the down payment, and the closing costs.
We used a gap clause on our most recent purchase. The list price was $415,000. I was confident that an appraisal would cover up to $425k, but I didn’t see many comparable sales higher than that without venturing into different neighborhoods. We offered, with an escalation clause, up to about $450,000. Since we weren’t sure that the appraisal would go that high, we offered a gap clause of $25,000. Our final purchase price was $438k, and the lender waived an appraisal need, so our gap clause wasn’t enacted.
I mentioned that a contract can almost say whatever you want. Here are a couple of examples of protections we put in an offer that had to be satisfied within the term given or we could walk away from the deal with no penalty.
SELLER THOUGHT PROCESS
The seller’s comfort comes into play when you’re in a multiple offer scenario. A buyer can make an offer saying almost anything they want (within reason of a residential real estate transaction). You can manipulate your offer to show the seller how vested you are in the purchase. Sometimes a seller just cares about the bottom line numbers, but sometimes (like if you’re competing with a similar offer), a few tweaks to your offer may make you more desirable.
I mentioned that we went higher than 1% on our EMD for our personal residence purchase. We wanted to show that we were very interested in the property, so one way to do that is to show that we have a lot of “skin in the game.” If we default on this contract, we’re out $5,000 and getting nothing. Whereas, when we’re purchasing a rental property without emotion, if it doesn’t go through, it doesn’t go. Sticking to about 1% is showing that we’re “checking the box,” but not that we’ll do anything and everything to make sure this deal goes through. We would still be out some money and get nothing if we walked from a contract without enacting a contingency, so the higher EMD you include, the more serious you appear.
A seller may not understand the big picture of providing the subsidy, so that could be risky. If a seller sees that they’re contributing to $2,000 of your closing costs, they may balk at it. Hopefully, they have a realtor on their end that can explain “think of your offer as $100,000 instead of $102,000.”
Eliminating a home inspection may make a seller feel more comfortable too. They may know of some issues in the house and are waiting for the “shoe to drop” through the inspection process, so it could eliminate a stressor for them. I wouldn’t recommend eliminating a home inspection unless you’re confident there aren’t any fatal flaws in the house (e.g., quarter width cracks in the foundation, wet marks on the ceiling, warped/sunken flooring).
The housing market has slowed down, so some of the out-of-the-norm clauses may no longer be worth the buyer’s risk just to compete for a house, but these are some options out there. The general concepts still apply, like when to pay for extra inspections or to expect financing and an appraisal to go together. Know that everything is a negotiation and don’t feel stuck in a contract if red flags are flying.