Making an offer on a home can feel like it’s happening so quickly that you haven’t had time to think. Take some time to make sure you (and anyone else you’re shopping with) understand all the important parts of the offer contract, especially the reasons you’re allowed to withdraw from the offer. These are called “contingencies” and they are put in place to protect your earnest money.
This is an excerpt from Chapter 10 of First-Time Home Buyers: The Complete Playbook for Avoiding Rookie Mistakes by Scott Trench and Mindy Jensen. For more tips on first time home buyers, find the book at BiggerPockets Bookstore!
What are contingencies?
It’s a fancy word for “situations”. I will pay you for the house on the contingency that all goes well with the inspection. I will pay you $100,000 contingent that the property appraises for at least $100,000. If the property appraises for only $99,999, I do not need to continue with the purchase.
Remember when your mom told you that no one wins with ultimatums? 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 case anything goes wrong during the buying process. If something goes wrong, the contingencies in your contract allow you to back out of the purchase without losing your earnest money.
Connected: Earnest Money: What it is, why it’s important—and how to protect your deposit
What is earnest money?
In addition to signing your offer agreement, you will submit an earnest money check. This shows the seller that you are serious about your offer and that you are willing to put your money where your mouth is. The amount of the earnest money deposit will be decided by the listing, but this number is the minimum amount required. If you are against the competition, you can always make your offer stronger by increasing the amount of Earnest Money.
Luckily, your earnest money payment doesn’t just disappear. It is credited towards your down payment at the time of closing. For example, if you write a check for $10,000 for the earnest money, that will roll over to cover some of your down payment and closing costs. If your down payment and closing costs are less than that amount, you’ll get a refund once you own the home.
Unfortunately, the seller can forfeit the earnest money if you don’t abide by 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 also want to make sure you’re on top of those as well. Enter everything into your calendar and set an alert for the day before to make sure you stay on top of everything you need to get done. Although your agent should help remind you, you will most likely be hurt if you miss a deadline.
When can I get the Earnest Money refund?
It entirely depends on the “contingencies” clause of your contract. Typically, as long as all deadlines are met, a buyer is allowed to back out of a deal for five common contingencies: loan approval, home sale, home inspection, appraisal and title insurance.
Loan Approval and Home Sale
If you are currently living in a home that you must sell before you can buy another, this would be a home sale contingency. Also, it’s no big surprise that your lender needs to be able to underwrite and approve your loan before you can buy a home. If any of this fails, there is usually an escape hatch built into the contract with which you can keep your earnest money.
home inspection
If you hire a property inspector and they find the house is falling apart, you should be able to return and keep your earnest money. The extent to which you can do this depends on your contract and whether you have included an inspection contingency.
With an inspection contingency, you can make it clear to the seller that you are not going to negative on everything in order to further negotiate the price. Essentially, you wouldn’t ask for repairs on “little things” in the inspection report.
If you’re only getting an inspection to check major items — such as the HVAC system, roofing, structural integrity, and radon levels — be sure to note this in your proposal and specify what’s needed to pass the inspection. . This contingency is especially helpful if you’re buying an old, unattractive home for appreciation. You probably don’t care if there are stains on the antique shag carpet when you’re planning on airing it out anyway.
Evaluation
A third-party professional will do the appraisal to make sure the home’s value and the purchase price are not miles apart. The appraiser will look at comparable properties that have recently sold — the same properties we told you to look at with your agent to determine the purchase price — and use those comps to determine the home’s value.
Your contract will probably have an appraisal provision section that outlines the appraisal process, who pays for it, and what happens in the event the appraisal falls under the value.
For example, if a buyer makes a $410,000 offer on a home appraised for $410,000, there are three options. The seller may agree to lower the price, the buyer may bring an additional $10,000 to the table so that the loan amount does not exceed the home’s value, or the buyer may back out of the purchase entirely. If this is specified in the contract they should be able to go back and still keep their earnest money.
Connected: What is underwriting? here’s what to expect
title insurance
Put as simply as possible, title specifies who owns the rights to the property. When you buy a home, there is a title transfer in which you are given ownership of the property and the seller relinquishes ownership in exchange for selling the home. 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 the property to the person who built the house there. However, if he pulls fast on the buyer and his great-grandson has legal rights to half the land under your house, there could be trouble down the line for you.
Similarly, if the home’s previous owner never paid for a $30,000 roof replacement, there may be a lien on the home so the roofer can finally get their hard-earned money. If you don’t take this into account when buying a home, that $30,000 will be your problem.
Your contract will include a few different title time frames during which the seller will provide a copy of their current title and you and your agent can scope it out for any defects. There is also a title objection and title resolution deadline before which you can point out and resolve any problems or withdraw from the offer altogether without losing the earnest money.
Solving title problems can be very complex or very simple. A property with title problems may not be covered by title insurance at all, or the insurance policy may exclude the problem—which means you may lose your interest in the property. Title is complicated, so be sure your contract allows you to back out in case of a title emergency.
If your home sale falls through, all hope is not lost. Follow these tips to get a refund on your earnest money—and buy First-Time Home Buyers: The Complete Playbook To Avoid Rookie Mistakes For more smart home buying tips.
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
