With few exceptions, the first week or two after you contract on a property are among the busiest and most important in the home buying process. You will be conducting inspections and other evaluations of the property and getting the lender geared up to finalize the loan on the property. You will also be reviewing documents from the title insurance company and coordinating with the lender to get the property appraisal completed. We’ll discuss this process under the following headings:
- Evaluating the Property
- Dealing with Financing Issues
- Evaluating Title and the Home Owner’s Association
If the closing has been scheduled less than 30 days out, you will also be preparing to move and close at the same time, but we’ll deal with those issues separately in the section titled Preparing to Close.
Evaluating the Property
As indicated elsewhere (see Risk and Pitfalls), there are a host of other issues that may need to be addressed to evaluate whether you ought to g through with the purchase of the property that you now have under contract. These issues may be more important than the physical condition of the property itself. If you overlook the fact that the roof needs to be replaced, you may be out $2,000 to $10,000, but you’ll also have a new roof with 20 years of wear on it. If you overlook the fact that your new home is 500 yards from the end of the airport runway, or that the “open space” behind your home is actually the loading dock for the new neighborhood grocery, the value of your new home may have just dropped $50,000 to $100,000 and there is nothing you can do to fix it. Worse yet, what if there are massive amounts of toxic metals in your water supply and you don’t get around to looking into that until after you and your children have lived in the home for a decade. In this context, a rusted out water heater can start to look pretty trivial.
When you draft your purchase contract, I would strongly recommend expanding the standard inspection clause to permit investigation of any other issues necessary to insure that the home you’ve contracted on will be a good investment and a good place to live.
In the the standard Colorado purchase contract, the inspection clause gives the buyer the right to conduct inspections of the “physical condition of the Property and Inclusions.” The word “inclusions” refers to the personal property included with the sale, property such as the oven, the dishwasher, and the hot tub. The clause provides that the condition of the property and inclusions must be satisfactory in the buyer’s “sole subjective discretion.” If not, the buyer has the right to either terminate the contract or ask the seller to correct the problems. When properly completed, the clause specifies a deadline by which the buyer must complete inspections and deliver a written objection OR termination notice to the seller or the seller’s agent. It also specifies a deadline by which the buyer and seller need to agree on what will be done to resolve the buyer’s objections:
A few comments
- Expand the Clause This clause was written to give the buyer wide latitude in determining what constitutes a problem and in deciding what they want done about it. But remember, the clause refers only to the physical condition of the property and inclusions. You may be able to argue that radon levels or contaminated water supplies fall under this umbrella, but it would be better to explicitly expand the coverage of the clause by explicitly listing these issues when you draft the offer. If you are concerned with issues like school districts, flood plains, airport runways, or coal mines, you clearly need to amend the standard contract to include these issues within the purview of the inspection clause.
- Time Frame is Critical Because your rights to object and terminate are so broad, the seller will want to limit the time frame for the inspection. If you write an offer that gives you a month to do the inspection, the seller will almost certainly counter or reject the offer. Typically, 5-10 days is adequate for inspections, but you need to check with inspectors and the other experts involved to make sure that they can complete their evaluations and reports within the time provided. If you don’t complete your inspections by the deadline, you have effectively waived your right to object or terminate.
- Everything is Negotiable, Nothing Required Though you have wide latitude in determining what you want to object to, the seller is under no obligation to do anything to remedy your concerns. If your requests are unreasonable or unusual, the seller may well decide to let the contract terminate. No matter how reasonable your requests, however, the seller is not obligated to fix anything unless they agree to in writing in the inspection resolution agreement.
As a practical matter, it is unusual for the buyer to terminate the contract over an inspection issue relating to the physical condition of the property. Since most physical defects can be fixed for a few hundred dollars, or at most a couple of thousand, the buyer will usually ask the seller to repair these defects rather than terminate the contract. Typically, there will be 3-10 days after the objection deadline for the buyer and seller to try to reach agreement on what the seller will do about the issues the buyer has raised. If the problems are routine, the decisions are fairly easy. If they are unusual or expensive, the buyer and seller may have get bids from contractors in order to evaluate the situation. Some sellers are quite reasonable in responding to inspection issues. Others, especially in a hot market, may refuse to do anything.
In our experience, there are three factors that determine whether you’ll get a positive response to inspection objections:
What Would the Next Buyer Do? The seller will typically be most responsive to issues that most other buyers would be concerned with too, issues such as a faulty electrical system or a leaking roof. These objections seem reasonable to the seller, and, if they let you terminate the contract over the issue, they know the next buyer is likely to object too. In contrast, if you object to minor scratches on the stair rail or to spots on the carpet, the seller may be tempted to let the contract terminate and hope the next buyer will be less picky. Oddly, this generally means that the seller will be more likely to agree to fix the more serious and therefore more expensive items.
Seller’s Want Clean Fixes. The seller won’t want to agree to fix things if there is substantial gray area between “fixed and not-fixed.” If the Seller agrees to have a furnace or electrical system repaired, it is generally fairly clear when the work has been completed properly. In contrast, if you ask the Seller to fix a loose stair rail, she may be concerned that you won’t think it’s good enough even after she’s paid somebody to do the work. All stair rails will wobble if pushed hard enough and the Seller doesn’t want to have inspection issues left up in the air to turn into disputes on the day of closing.
The Seller’s Fear of Loss. The seller is more likely to agree to pay to have things fixed if he fears losing you as a buyer and if he is truly concerned that you may let the contract terminate if he doesn’t complete the requested repairs. The seller is more likely to fear losing you as a buyer: (1) in a slow market than in a hot market, (2) if the scheduled closing is a week rather than 3 months away or (3) if he feels he’s getting a good price for his property in his contract with you. Even if the seller wants desperately to keep the contract alive, he may refuse to address your inspection concerns if he is convinced that you’ll buy the property whether he does the work or not. If you offered him $20,000 over his asking price, he may guess that you’re unlikely to back out if he refuses a $500 repair. Similarly, if you have the bank send the appraiser out (at a cost of $350) before you’ve resolved the inspection issues, the seller may guess that you’re planning on going forward with the purchase no matter what he does.
Dealing with Financial Issues
First, you need to get a copy of the contract to the lender so that they know critical contract terms such as the purchase price, the loan type and amount, the location of the property, and the contract dates and deadlines. If you don’t have a loan commitment from the lender yet, the lender needs to know the date by which they need to complete the loan approval process. That date is established in the contract, as are others that are critical to the lender, such as the appraisal deadline and the closing date.
The lender also needs to begin the process of reviewing and approving the property for the loan. Full loan approval requires not only that the lender approves you as a credit risk, but also that it approves the property as collateral for the loan. The appraisal (see Appraisers) is one of the more ubiquitous aspects of the lender’s evaluation of the property. With condominiums or town homes, the lender will also look at ratios of owner occupied properties to rental properties. With mountain homes, they may look at issues such as access, water supply, and the relative value of the land to the house. You also need to get copies of all subsequent contract amendments to the lender as soon as they are completed. Many minor disasters and frustrating delays occur in real estate transactions because someone failed to notify the lender or the title company of changes in the closing date or changes in the terms of the contract.
Second, you need to start talking with the lender about “locking” your loan as soon as you go under contract. When you “lock” your loan, the lender is committing to provide the loan at a specific interest rate and terms. You are committing to take the loan at that rate, assuming the lender approves the loan and you close on the home. Generally, lenders will not lock the loan until you have contracted to purchase a particular property. When you lock the loan, they are committing to accept the loan funds at a specific rate from their funding sources. If they fail to close on the loan, they may lose money. For the same reason, once you’ve locked a loan with a lender, they are generally not going to give you better terms if interest rates drop before you’re ready to close. And keep in mind that your loan lock must be carefully coordinated with the closing on your home. Rates are locked for limited periods of time, typically 30, 45 or 60 days. If you fail to close within the allotted time frame, your lock will generally expire. This can complicate matters when the contract does not specify a specific closing date, a common situation with new home construction.
Third, you need to work with the lender on the timing of the appraisal. In the typical transaction, where we have at least 3-4 weeks between contracting and closing, we try to put off the appraisal until after the buyer and seller have resolved inspection issues. You don’t want to pay $350 for an appraisal and then terminate the contract over an inspection issue. You need to let the lender know that you want to wait on the appraisal, but you also have to make sure that you allow the lender time to get the appraisal done within the time frame provided for in the contract. If the appraisal isn’t completed by the contract deadline, you may lose your rights to terminate the contract or renegotiate the contract price if the appraisal comes in below the contract price.
In general, communication with the lender is critical at this juncture. Any change in your contract with the seller, and any related agreements such as those involved in the inspection resolution, need to be communicated to the lender as soon as possible. In fact, the best practice is to review with the lender any changes to the contract or any other agreements you’re discussing before they are finalized. Depending on the issue and the type of loan, the lender may not allow certain agreements you and the seller make about resolving inspection issues. And if you and the seller want to extend the closing date by a few days, or if the seller wants to stay in the property for a period after closing, you need to know whether the lender will fund the loan under these circumstances before you sign the agreement.
Evaluating Title and the Home Owner's Association
While title insurance policies are designed to cover you if there is outright fraud in the sale of the property — if it was the husband’s girlfriend rather than his wife that signed the closing documents for example — these kinds of problems are not common. Typically, our review of the title commitment focuses on four issues:
- Limitations on Use. As I’ve noted elsewhere, your right to use your property can be limited by local regulations and state laws. But there can also be use restrictions that are connected with a specific property or set of properties. Subdivision covenants can limit the way you use the property, as can limitations placed in earlier deeds by a previous seller or agreements between the city and a developer.
- Obligations of Ownership. Financial and other obligations can be recorded in similar ways. In the mountains, for example, covenants, deeds, or other agreements can create obligations to contribute to building roads, plowing roads, or drilling and maintaining wells.
- Rights of Others to Use the Property . Almost without exception, others will have “easements” which give them the right to use portions of your property for specific purposes. In nearly all residential subdivisions, there are easements that allow utility companies to install and maintain utility lines on certain portions of your property. Easements can also give someone the right to drive across your property, fly over your property, mine your property, or visit their wife’s grave on your property.
- Liens Against the Property. A lien is a record of a right to collect money when a property is sold. Lenders file liens to record loans on a property. Governmental entities file liens to record taxes owed by the properties owner. Contractors and vendors file liens to record money owed for work they have completed or products they have installed on a property. You don’t want to buy the property with the lien in place.
In the title commitment, the title company will reference recorded documents that can create these kinds rights and obligations. In some cases, references to problematic issues will be obvious, a reference to a $30,000 tax lien for example. In others, the commitment may simply refer to the subdivision covenants. If you don’t read the associated document carefully, you may not learn about your responsibility to provide easements, to pay for road construction or maintenance, or to get permission from your neighbors to change the color of your house. You need expert assistance, either a good real estate agent or a good real estate attorney (or both), to assist in the review of the title commitment.
There are four parts to the title commitment:
- The Pre Printed Form. The pre printed language that outlines the general parameters of the coverage and the title company’s commitment to deliver the insurance policy.
- The Descriptive Details. A page listing the property covered, the type of policy to be provided, the names of the buyer and seller, and the cost of the coverage. Check to make sure they have your name spelled right!
- The Requirements. Schedule B, Section 1 (Requirements) is where the title company outlines what they will require before they will close and insure the property. Typically, this refers to routine things such as the signing of the deed, the payoff of the seller’s loan, and the recording of your loan. But this is also where they’ll reference liens that need to be paid off before the sale closes.
- The Exceptions. Schedule B, Section 2, (Exceptions) is the list of items that the company is “excepting” or excluding from coverage, the list of documents placing limitations on your rights to the property that they are not going to insure you for. This is where they’ll have the documents, like subdivision covenants or road maintenance agreements, that limit your rights to the property or create financial obligations for the owner of the property. This is also where they will list documents that give others rights to use your property via easements or other means.
We typically recommend that our clients obtain a specific type of title insurance policy called an ALTA Residential policy rather than the standard ALTA Owners policy. This policy is commonly called an “extended coverage” or “plain language” policy. This type of policy provides substantial protection not provided in the standard policy. For example, it insures the buyer for liens filed on the property after closing, but arising from actions of the previous owner, and for any damages that might result because of survey errors.
If serious problems are reflected in the title commitment, the standard Colorado contract gives the buyer the right to object to these problems and to let the contract terminate if the seller cannot address them to the buyer’s satisfaction before closing. If there are subdivision covenants that the buyer is uncomfortable with, the seller will generally not be able to do much about that. In other situations, however, there may be things that the seller can do to address a problem. They may be able to purchase additional insurance coverage through the title company that will make the buyer comfortable. They may even be able to convince neighbors to give up easements that the buyer is worried about.
While surveys are not produced by the title company, the information reflected in the survey overlaps substantially with the information in the title commitment. For example, easements described in the title commitment, at least the most common easements that provide a right to use a limited portion of the property, should be reflected on the survey. Similarly, if the survey shows that fences or decks extended beyond the property lines, the title company will list this “encroachment” as an exception in Schedule B-2. This means that they will not cover you if you suffer damages as the owner because these structures extend onto your neighbors property.
The title company should also provide the buyer with a copy of the tax certificate indicating the tax levy on the property, the taxing districts to which taxes are due, and a statement indicating if there are any unpaid taxes or assessments on the property. The standard Colorado contract gives the buyer the right to review tax levies within “special taxing districts” and to terminate the contract if they are unsatisfied. To exercise this right, however, you need to obtain the information and object by the title objection deadline. It should also be noted that the clause as written is somewhat ambiguous, given that there is no clear definition of what a “special taxing district” is.
At the same time that you’re receiving the title documents, you’ll be receiving documents from the Home Owners Association if you’re property is governed by one. If you do this right, you’ll have the option of reviewing all the rules and regulations of the HOA, their financial status, and the minutes of recent meetings of the owners and the HOA board of directors. If you find things in these documents that you’re not satisfied with, a properly drafted contract will give you the right to terminate the contract.