In the last posting I spoke about how to make a stronger offer when you want to purchase a home. One of the main contracts that is used is the Residential Purchase Agreement. This 8 page document is the back bone of buying a home. It is absolutely critical that a buyer understands this contract.
Disclaimer: what I am going to write is only a guide for educational purposes and hits on only a few key items from the contract. When it comes time to a purchase you must go over, in detail, this entire contract with your real estate agent. If you have any questions, ask. It is incumbent on you to protect yourself. If you are still uncertain about anything in the contract seek further clarification. After all, a home purchase is probably the most expensive purchase in your lifetime.
Page 1 of the contract contains the key financial information about the purchase. There are 4 main financial parts:
1. Purchase amount
2. Ernest Money Deposit
3. Loan type
4. Down payment
5. Considerations and Terms
Purchase amount is the total price you are offering for the home.
Earnest money deposit (EMD) is a symbol of your seriousness in purchasing the home. This amount of money will be deposited into escrow upon complete (executed) agreement between buyer and seller within 3 business days. The number one question I am asked is ‘how much’ should it be. Well, this is a discussion you will need to have with your real estate professional.
Loan type is an indication of the type of loan you will primarily seek for the purchase. As I mentioned in article 3; this could affect the seller’s decision so you must disclose it. Since you already have the prequel letter (article 1) you should know the answer.
Down payment is the amount of money the bank will require you to put up in order to secure the loan. This can be from anywhere from 0% to 20% (or more if you wish) of the purchase price.
Consideration and terms are any other financial aspects of the loan; for example, if you are asking the seller to cover a portion of the closing costs.
Page 2 outlines timelines to complete duties; these are called contingencies. There are several time lines involved in the contract for both the seller and the buyer.
Buyer Timelines (summary, not a complete list):
1. Verification that you have the down payment monies; 7 days from acceptance
2. Loan application and approval letter; 7 days from acceptance. But since you got preapproved before you began your home search you already have this done.
3. Loan contingency removal; 17 days
4. Appraisal contingency removal; 17 days
5. Physical inspection(s) removal; 17 days
What is a contingency? A contingency is a built in protection for the buyer. When a home buyer makes an offer they set in motion the process of buying a house but they are not 100% locked in to buying the home. The contingencies allow the buyer to cancel the contract if a contingency fails.
The loan contingency is based on the buyer obtaining a loan. A prequalification letter is step one in the process but it is not an in-depth analysis of their credit worthiness. During the beginning of the escrow period their lender will dig deep into their finances in order to answer the question, ‘will this buyer be able to make their monthly payments.’ If the answer is no then the loan contingency fails and the buyer can terminate the contract without losing their earnest money deposit.
The appraisal contingency is also loan based. The buyer and seller may agree that the offered price is a fair price. But the buyers lender gets to examine the home and determine if in their opinion the house is worth the price (structurally as well as fiscally). If the appraisal comes in lower than the offer price there is a problem. Either the buyer and seller have to agree to a new price or the contract terminates. Again the appraisal contingency fails so the buyer may cancel the contract without losing their deposit.
The third and final contingency is the physical condition of the house. Visiting the home is step one but that is only a surface look. A buyer will want to check out the true structure of the home. As a buyers representative the very first thing I do when the buyer and seller agree to a price is to have the buyer order a physical inspection by a licensed and qualified inspector. This inspector will spend 90-150 minutes and test the entire house. They will look at the structure, the foundation, the roof, insulation, the plumbing, the electrical, and more. Their job is to try and note any problems. The report they will give you will tell you of items that are in good working order, items that need to be replaced or updated, or items to keep an eye out on. If they find a potential problem the buyer can thing bring in a specialist to really examine if there is a problem and give estimates on repairs.
If a physical problem is found the buyer can either accept the issue as something they will correct (as long as it does not affect the loan approval process) or they can ask the seller to repair the problem before the close of escrow. The seller does not have to agree to the repairs.
If the physical inspection fails, in the opinion of the buyer, and they wish to cancel the contract they may do so without putting their deposit into jeopardy.
As mentioned above, all 3 of these contingencies default to 17 days (the number of days can be changed during the contract writing). The buyer must complete all these steps within that timeframe and then remove their contingency or cancel the contract.
As we move to page 3 of the contract one of the major sections here are the seller duties to the buyer to pass on knowledge about the home. These are called the seller disclosures. Since these disclosures could affect the buying decision of the buyer the timeline is much tighter; typically the seller has 7 days to disclose (summary, not a complete list):
1. Are there tenants in the home
2. Is their lead based paint in the home
3. Natural hazard disclosure (prepared by an outside 3rd party)
4. Environmental hazard disclosure (prepared by on outside party)
5. Withholding requirements or waiver
6. Condominium disclosures including 12 months of HOA minutes, HOA Covenants, Conditions, and Requirements (CC&R)
7. Seller’s Transfer Disclosure Statement
The goal of all of the disclosure is to reveal (disclose) about the home. These may reveal material facts. A material fact is a fact about a home that could affect the buyer’s decision to continue the purchase of the home. Who gets to determine what a material fact is? The buyer makes that determination. The seller does not know the buyer so the seller must disclose absolutely everything and let the buyer decide. Withholding a material fact could result in a cancelled contract or even litigation. When I represent a seller they may ask me ‘do I need to disclose this.’? If you have to ask then the answer is yes. It is always better to over disclose than to under disclose.
Of the disclosures I am only going to speak to the last one I mentioned; the Transfer Disclosure Statement. This is a 3 page form that discloses what it is like to live in that home. After all, who knows more about actually living in the home then the person who has lived there for years. The nice thing about the form is that is walks the seller though everything about the home, to help them think about each section and to complete the form.
• I had to fix a water leak in the walls 20 years ago and it hasn’t leaked since, do I disclose that? Yes.
• I live on a street where all the houses decorate their homes with lights and during December there is excess traffic. Do I disclose this? Yes.
Literally, everything that could affect the buyer’s decision to purchase the home must be disclosed. Remember, it is the buyer that gets to determine what is a material fact; not the seller. While I picked out a couple extreme items the transfer disclosure is designed to aid the seller walking them through plumbing, roofing, electrical, structural, landscape, and other such items. If you are selling your home I suggest that you prepare the Transfer Statement as early as possible even while the home is on the market waiting for an offer.
Vesting and Title
One critical item you will find on page 4 is the admonition to the buyer to consider early how they plan on taking title; also known as vesting. There are many ways a buyer can take title:
• A single man or woman
• A married man/woman as their sole and separate property
• Joint tenants
• Community property
• Community property with right of survivorship
• Tenants in common
• Corporation (or other business entity)
Every single one of these vesting options are different and have extremely important tax and inheritance implications. It is so important that I will not discuss them here. When working with my buyers I have handouts that I can give them to help them understand each of these options.
In working with buyers I can answer questions about vesting options but I cannot aid in the decision. This must be made solely by the buyers. Again, that is why the buyer is cautioned to think about them early that way they have time to get the answers they need. To learn more about what a title company does and why title insurance is important please read this article.
On page 5 of the RPA you have the major section that determines the major timelines (buyer contingency and seller disclosure.) It is here that the default days of 7/17 can be altered. Also on page 5 are answers to the questions of what happens if a party misses a timeline and what happens once contingencies are removed.
As mentioned, by default, the seller has 7 days to deliver their disclosures and the buyer has 17 days to remove their contingencies. But what if one of the parties fails to complete their task? Does the contract end? The answer is no, not yet. The offended party has to issue the non-compliant party a form called ‘notice to perform.’ It puts the party on notice that they must perform their duty. If they fail to perform within the timeframe then the contract MAY be cancelled.
One of the last major steps in the escrow period is the removal of the contingencies by the buyer. The major affect of contingency removal is that the buyer acknowledges that the home is in acceptable condition and the buyer wishes to conclude the purchase.
The Final Pages
I will not get into pages 6, 7 and 8. These pages cover terms, escrow instructions, dispute resolution, and the signature page.
As I conclude this article let me once again stress that this was a very cursory look at the purchase contract. The full contract has 30 major sections with many sub-sections. As you can see I only covered a small percentage. When you purchase a home make sure that you go over the entire contract in detail.
Now let is journey on to look at the escrow process.