I’m frequently asked by my buyer clients, usually first time buyers, about the level of commitment they have to make when offering to purchase a home. They are concerned about the amount of money they have to commit, and if they can get it back if anything goes wrong.
For the purpose of this discussion, it is assumed that the buyer will use the standard Arizona Association of Realtors purchase contract and addenda. It’s also assumed that the offer is for a “normal” listing, and not a bank owned or short sale. Bank owned and short sales usually have other earnest money and contingency requirements that are not in the standard contract.
Earnest Money
It is expected by the seller that the buyer will provide an initial deposit, called earnest money, to show they are serious buyers. Typically the amount is around 1%-3% of the purchase price. Higher amounts if you really want to impress the seller. The earnest money check is made out to the title company. In some cases, it may be specified that the earnest money will be wired into the title company when escrow is opened. This is typically done to accommodate out of area buyers.
The buyer’s Realtor holds the earnest money check until the offer is accepted. Escrow is then opened by the Realtor who deposits the check with the agreed upon title company. If the offer is not accepted, the check is returned to the buyer (or held for the next offer).
The title company holds the earnest money until either the purchase is completed (closed), or a contingency is exercised which cancels the purchase and requires the disbursement of the money to the buyer or to the seller depending on the contingency conditions.
In the case of a completed purchase, the earnest money is typically applied to the down payment if financing, or as part of the full cash payment for an all cash purchase. However, the buyer may direct the money to other closing costs when writing the offer.
Contingencies
A contingency is a specific situation that must be completed or there are consequences such as cancellation of the contract and/or loss of earnest money. Standard contingencies include inspections, loan commitment, appraisal and the Commitment for Title Insurance. You may include other contingencies as long as the seller agrees to the terms.
Loan Contingency
The loan contingency says that the buyer’s purchase is contingent upon the buyer obtaining loan approval without conditions no later than the close of escrow date. If the buyer is unable to obtain a loan despite good faith efforts to do so, then the buyer may get the earnest money returned. However, lack of down payment money or other funds needed to obtain loan approval are not grounds to get earnest money back. Pre-paid items paid separately are not refundable, such as appraisal or credit check expenses. Also any charges made to escrow may be deducted from the earnest money, such as the cost of termite inspection.
Appraisal Contingency
The appraisal contingency requires the home to appraise for at least the purchase price if the buyer is getting a loan. If it does not appraise, the buyer may cancel within 5 days of receiving the appraisal notice and have earnest money returned, otherwise this contingency is waived. Typically, the buyer will request that the seller lower the price to the appraised value, but the seller is not required to do so. Another option is for the buyer to provide additional cash to make up the difference between the purchase price and appraised value, but this is not common (you REALLY have to want the home to buy it for more than market value).
If paying cash, an appraisal is not required and is not a contingency unless specifically requested in the offers additional terms and conditions. Unless you are sure your cash offer is within market value for the home, I’d strongly recommend putting in an appraisal contingency. Having this contingency saved one of my cash buyers, and was part of our strategy. We knew the seller would not accept an offer at the market value, and so we used the appraisal contingency as a tool to force renegotiation. If the seller would not reduce, then we could walk away and only be out the cost of inspection and appraisal. We got the lower price.
Inspection Contingency
The inspection contingency allows the buyer a set amount of time, usually 10 days in the standard contract, to inspect the property for any conditions that are not acceptable. The buyer may either request such conditions to be repaired, or cancel the contract. If the buyer elects to cancel within the inspection period, then the buyer is entitled to return of the earnest money. If the buyer does not cancel, then this particular contingency expires and inspection results are no longer a valid reason to cancel or to get earnest money back.
Title Contingency
When escrow is opened, the Title Company is instructed to deliver a Commitment for Title Insurance to both the the buyer and seller. Exceptions to the title insurance policy will be listed, such as a homeowners association’s CC&Rs (Conditions, Covenants and Restrictions), deed restrictions, and easements. The buyer then has 5 days from receipt of any exception notices to “disapprove” of any exception item. Disapproval takes the form of a cancellation notice and return of earnest money.
Contingencies are there to protect both the buyer and seller. Part of my job as your buyer agent is to keep an eye on the contingency conditions and time frames and help you deal with them.
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