Tools for Protecting Yourself During a Home Purchase

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It's not the tone of their voices or any perceptible shifting in their seats.  My clients are pretty good at what they do and there's a certain confidence that comes from that.  But no matter how many times you've done it before, it's still a big step. 

There's the unknown: you may never meet the sellers to understand how they've always made sure to grease the garage door or kept the bathroom tiles consistently dry.  You might not even be from the area and have a clear picture of how different Palo Alto and East Palo Alto are, much less whether Cupertino, Saratoga or Portola Valley would be a better fit for your family.  

Plus, there are the large numbers involved.  Silicon Valley real estate has high prices compared to most places in the U.S.  It's the price homeowners pay for the combination of the opportunity, the weather, the culture, and being a road trip away from the Pacific, San Francisco, Napa, Lake Tahoe, Yosemite, and even Los Angeles.

Just add public speaking, heights and spiders to the unknown and large numbers, and you've probably rounded out the top five list of people's biggest fears.  Some are so afraid that it keeps them from making decisions they know will make them happy.  (See the article Emotions in Real Estate: From Fear to Elation.)

I believe an important part of my job is empowering people to make good decisions --- ones that help them achieve their goals and aspirations --- in the face of stressful situations.  And, here, preparation is key.  My clients can help by ensuring their finances are prepared.  (See the article Preparing Money for Buying a Home.)

But another way of becoming empowered to make choices that help you achieve your goals is to understand some of the tools which we can use to help protect you in the process and what value you can expect in return if you decide to waive their use.

Contingencies: A Buyer's Money-Back Guarantee?  Not Exactly.

Let's say you've found a home that you really like and we've worked together to figure out how much you'd pay for it.  (See the article The Thought Process Behind Making an Offer on a Home.)  Then we walk in the seller's shoes to understand how much they may want.

Now you're considering non-monetary ways of strengthening an offer.  (See the second-half of the article Not Overpaying When Buying a Home.) 

When you make an offer on a home, you have the right to ask for certain conditions to be met after the offer is accepted and before you agree to complete the purchase.  These conditions are known as contingencies, and the period of time in which those conditions must be met is known as a contingency period.

Buyers have to explicitly lift contingencies in order for the sale to proceed, so if the seller accepts a contingent offer, they're also agreeing to allow the buyers to back out of a purchase --- without losing their earnest money --- during the contingency period.

Sellers obviously dislike contingencies because they have to take their home off the market once in contract, then risk having to re-list their homes if the buyers don't lift any one of the contingencies in the contract.  The shorter the contingency periods, the stronger the offer.

Inspection Contingency

The inspection contingency is the most common type of contingency period and allows you to investigate the desirability and condition of the property to your satisfaction.  You might, for example, get a professional inspection, hire a structural engineer, obtain estimates on any repairs or upgrades you'd like to do during this period, or thoroughly read the disclosure packet.  (See the article Why the Perfect House Wasn't So Perfect.)

This is effectively your due diligence period, and it's one way of protecting yourself when purchasing a home.  Buyers get to look at the property without rose-colored glasses and then negotiate compensation or repairs from the seller for any items that weren't accounted for in the offer.  This is the way I recommend my clients look at inspection contingency periods.  

In extreme cases, this contingency provides a grace period when buyers can either confirm that they want to complete the purchase or back out without losing their earnest money (deposit).  There is a cost for doing this, however, as the buyer's reputation may be damaged if the rationale for backing out of the purchase is weak and there was no attempt to negotiate a solution.

Offers with no inspection contingency, or no contingencies at all --- called non-contingent offers --- are very common in Silicon Valley.  Most sellers will pay for a professional property inspection to be included in their disclosure packets, and better agents will provide a complete set of disclosures online for easy access.  This allows buyers to do their due diligence before submitting an offer.  In fact, many inspectors will allow prospective buyers to call them with questions before making an offer.

Given two offers with the same price, the offer without contingencies is always better.  And there are cases where a seller would rather take a non-contingent offer than an offer with a higher price and one or more contingency clauses.  That's because all contingencies, no matter how benign sounding, have equal power (since all have to be lifted before the sale can proceed).  The inspection contingency, however, is the one most frequently requested. 

Financing Contingency

A loan contingency period allows you time to obtain a commitment from a lender to finance your home purchase.  In Silicon Valley, it's not unheard of to have "all-cash" offers where the buyer funds the entire home purchase, making this contingency irrelevant. 

More frequently, buyers need to obtain a mortgage.  The strongest offers will include a pre-approval letter.  (See the article Preparing Money for Buying a Home.)  This pre-approval letter isn't necessarily a commitment since that can only be obtained after the mortgage lender's underwriting department has given their consent.  But it does indicate that the chances of getting a mortgage are very good.

Not including a financing contingency is a show of financial strength.  Even though money from you and money from a lender all has the same value, sellers obviously prefer financially strong buyers because it reduces the risk of anything going wrong while their home is in contract. 

You can signal your strength through your down payment, your pre-approval letter, and removing the financing contingency.  Removing the financing contingency won't significantly strengthen your offer if you've included other contingencies, but signaling your strength as a strong buyer can only move your offer in the right direction.

Appraisal Contingency

This contingency goes hand-in-hand with the financing contingency.  In order for a mortgage to be approved, a lender's underwriting division has to agree to carry the risk of the loan.  One key component in this assessment is how much the property is worth.  If the property doesn't appraise for at least the amount of the loan, the lender may decide that the loan is not worth making because they are giving out more money than they have collateral to recover.

The appraisal contingency requires that the property appraise for at least the purchase price.  If it doesn't, the buyer can back out without losing the earnest money deposit.  The appraisal contingency and the loan contingency are often tied together --- it's important to build in time for the appraiser to be scheduled and to finish his or her report.

Sale Contingency

People relocating or moving up to a larger home often want a sale contingency which makes the purchase of their new home contingent on the sale of their previous home.  (See the second-half of the article Keeping Your Sanity While Moving Up to a Larger Home.)  This is possibly the riskiest contingency for a seller to agree to and many sellers would rather wait for cleaner offers than agree to one which would tie their sale to the sale of your home.

Where the Market Winds Are Blowing: Comparative Market Analysis (CMA)

I mentioned before that real estate is highly symmetric and that understanding how sellers make their decisions will help buyers make better offers.  (See the article How Buyers Can Walk in the Shoes of Sellers and Listing Agents.)

Buyers who are serious about making an offer can learn a lot from a comparative market analysis of properties that have recently sold in the area, as well as any properties that have recently been withdrawn from the market.  

My clients gain a lot of insight when we compare "the most relevant" comparables chosen by the seller with the ones we choose as the most relevant.  I recently listened patiently to an agent justify a higher price using a home with a larger lot in a more prestigious neighborhood as their closest comparable, when an almost identical property with similar upgrades, just down the sidewalk, commanded a price much lower than their asking price.  We negotiated for a little while, and I understood his position --- his clients had a number in mind --- but I was happy my clients could make a good decision using the "right" facts.

Buyer Agents vs. Double Agents

And the "right" facts in the "right" hands are important in real estate.  We're fortunate to be in a time when we've mostly moved beyond sub-agency, where an agent who actually represents and has fiduciary responsibility to the seller finds a buyer and helps facilitate that sale.  The buyer might tell the sub-agent the most they're willing to pay for the home thinking that the agent represents them.  In reality, that agent actually works for the seller's best interest and tells them that information, which, not surprisingly, leads to the buyer paying more than they have to.

Dual agency is more subtle and it can happen when you walk into an open house and you're approached by the friendly and knowledgeable real estate agent sitting at the dining room table.  (See the article Is Your Real Estate Agent a Double Agent?)  You're very interested in the house and he says that he can represent you in the transaction.  If you agree, you could be giving up your right to a buyer agent who solely represents your interests.  Would you go to court using your opponent's lawyer?