So you've got all your ducks in a row, found a home you love, and convinced the seller to accept your offer. Congratulations!!! This is a huge accomplishment. But, your work has only just begun. Now it's time to investigate the home and make sure it's going to be a good investment. Hopefully you won't find out anything horrible, but that's out of your hands at this point. Real estate is like litigation—never a sure thing, no matter how great your case is. In this post we'll be covering the flurry of activity that will take place when you open escrow. If you'd like to browse the other topics in this multi-part blog series on How to Buy a Home in California, please check out our handy Table of Contents.
Step 1: Earnest Money Deposit
You'll have to submit your earnest money deposit to escrow within 3 business days. The earnest money deposit is generally 1% of the purchase price, although it is negotiable in the contract, and sometimes sellers will require you to deposit more—up to 3% under California law. The reason they do that is because once your money is in escrow, the seller has to agree to release it back to you, and if you cancel the deal based on an invalid reason under the contract, the seller can keep your deposit.
You see, every contract in the state of California has an implied covenant of good faith and fair dealing. That means if you enter into a contract without a good faith intent to perform the terms of that contract, you may be liable for damages to the other party for wasting their time (and money possibly). In the home buying context, this means you have to intend to perform on the terms of the contract you negotiate with the seller. If you cancel because you simply change your mind (an invalid reason to cancel under the terms of the contract), the seller gets to keep your deposit.
This should never happen, because you have several valid reasons in the contract which allow you to cancel without forfeiting your deposit. But you have to abide by strict time deadlines and other rules in order to make sure you don't inadvertently lose your money. This is why you need a really great agent advising you and protecting your best interests every step of the way.
Buyer's Reasons to Cancel the Contract: Otherwise Known as "Contingencies"
Below we outline some of the safety nets that are built into the contract, knows as the buyer's "contingencies," which allow you cancel the deal without losing your deposit. But keep in mind that by the time you find out about these things and make the difficult decision to cancel escrow, some of your money will already have been spent—on the property inspection, or the appraisal, for instance.
You generally have only 17 days to do all of this homework and either cancel the contract, or commit yourself fully by "removing" these contingencies from the contract (i.e., forfeiting your right to cancel based on these reasons), so there's no time to waste.
Contingency #1: Investigation Into the Physical Condition of the Property
The first thing you want to do is hire a professional home inspector. Your 17-day investigation period goes by fast, and sometimes the inspector is booked out in advance, so as soon as you find out the seller accepted your offer, your next phone call should be to the home inspector. Your inspector will go through the home inch-by-inch and identify safety issues or items in need of maintenance, repair or replacement. You should be there during the inspection, follow your inspector around, listen and ask questions. Once you get the inspection report, you may want to hire additional specialists (e.g., a roofer or fireplace expert), or you might obtain bids from repairmen to get an idea of the cost of needed repairs.
If you discover a large, unanticipated repair item which might make you re-think buying that home, have your agent tell the seller. Keep in mind that the seller doesn't have to change the contract (all home purchases in California are "as-is" by default), but they might agree to a price reduction or to perform some repairs for the sake of keeping the deal together. If the seller doesn't agree to change the contract, you need to ask yourself whether you'd be willing to accept the home in this condition, or walk away. This is a valid reason to cancel the contract and get back what's left of your deposit.
Contingency #2: Seller Disclosures
During your 17-day investigation period, the seller will provide you with written disclosures regarding their personal knowledge of the property’s condition and location. The seller has a legal duty "to disclose any fact materially affecting the value and desirability of the property." Cal. Civil Code § 1102.1.(a) All disclosures must be made in good faith (honesty in fact).
The seller is also required by law to provide you with a "Natural Hazard Disclosure," which describes the environmental hazards present around the vicinity of the home. There are environmental hazards everywhere (all of San Diego County is a radon gas zone), but it's still important to make a fully informed decision about the home you're thinking of purchasing and what risks may surround it. You can also request that this report include disclosure of any property insurance claims made for the home in the last 5 years (called a CLUE Report).
Contingency #3: HOA Documents
If your new home is subject to an HOA, this is another hugely important area of investigation during your due diligence period. An HOA has so much control over your ownership rights. They have the ability to fine you and even foreclose on your home if you don't pay their fees. They can tell you what color you can or can't paint your home, whether you can put up a satellite dish, hang towels on your balcony, and so much more. There is enough to say about investigating your potential HOA that it deserves its own blog post. For now, just prepare to carefully review hundreds of pages of documents, and make sure you get all your questions or concerns addressed before you remove your HOA contingency. You'll definitely want to personally call the HOA, introduce yourself, tell them you're in escrow to purchase a unit in their complex, and make sure they're helpful and answer all your questions.
Contingency #4: Appraisal
This is a great safety net against overpaying for the home. When you get a loan, the lender will require that the property appraise for at least the purchase in order to fund the loan. If the property appraises for less than the purchase price, it's considered inadequate security for the loan, and your final loan approval will be reduced according to the deficiency between the contract price and the appraised value.
If the property appraises for less than the contract price, the buyer can walk away. But you've already paid ~$450 for the appraisal, and another ~$400 for the property inspection, and you've already fallen in love with the home, so it makes sense to see if the seller will reduce the price to match the appraised value. It's very hard for a seller to argue that you should pay more than an appraiser has determined is the fair market value. Usually properties appraise for the purchase price, but it's great for the buyer to have this additional security against overpaying.
Contingency #5: Loan Approval
If you don't get final underwriter approval for your loan, you won't be obligated to complete the home purchase. You can cancel the deal and get back what's left of your deposit. But no one should ever be in this situation. If you have an experienced, knowledgeable lender from the beginning, they'll be able to identify any potential challenges with your loan approval, and they'll be able to fight to convince the underwriter to approve your loan. Don't waste time with random internet lenders. You need someone local. Click the link for an overview of home mortgage financing, and contact our girl Kim Carlson at the links below for a detailed and honest look at what loan options may be available to you.
There are a few other contingencies you might have as a buyer, which protect you from being committed on the purchase contract under certain circumstances. But we've covered the major ones above.
Thanks for following our blog series on How to Purchase A Home in California! Find out what happens next in our next post about closing escrow. Thanks for sharing and letting us know your questions or comments below.