10 Hurdles To Closing On A New Home
Having your home purchase offer accepted is like getting that runner's high during a marathon. But hold the Gatorade cooler - the property isn't yours just yet. During the 30 days (or so) between when your purchase offer is accepted and when the keys are handed to you (commonly referred to as "escrow"), there are many hurdles to overcome. If you stumble on any of them, the purchase may fall through and put you back at the starting line.
Just like an athlete trains for a race, you can train yourself for the daunting final steps in purchasing a home. Escrow procedures and rules vary by state, but here are 10 of the most common problems encountered during this period, and what (if anything) can be done to prevent or mitigate them. (To learn about the steps that lead up to closing the deal on your new home and taking possession, read Understanding The Escrow Process.)
1. The termite inspection reveals extensive damage. The lender will have a pest inspection done on the home (at your expense - usually less than $100) to make sure there is no serious damage caused by wood-munching insects like termites and carpenter ants. This inspection protects the lender's interest in the property. Tenants who discover termite problems after moving in often abandon the property, which leaves the lender holding the bag. Some lenders may not require a termite inspection, but it may be in your best interest to get one anyway. If the inspection uncovers any evidence of visible infestation, the problem areas may have to be remedied before escrow can close. If the problems are too severe and/or the seller won't pay to fix them, you'll have the option to walk away, as long as your purchase agreement has the proper contingencies.
2. The appraisal isn't high enough. The bank will have the home appraised (again, at your expense) in order to protect its interest in the home. It wants to make sure the home is worth at least as much as you will be paying for it so that, if foreclosure is in the future, losses can be recouped. If the appraisal comes in too low, the seller will have to lower the selling price or you will have to pay cash for the difference. It may be possible to get a more favorable second opinion from a different appraiser. (Read more about buying a house in To Rent Of Buy? Part 1 and Part 2.)
3. There are clouds on the title. During the escrow process, you'll hire a title company to do a title search and issue title insurance. The title search ensures that no one else has a legal claim to the property you want to buy (such as the IRS, the state or a relative of the seller), and title insurance protects you against any future claims to the property. If there is some sort of lien or claim against the property, the issue will have to be resolved before the transaction can proceed.
4. The home inspection reveals major defects. Most purchase offers have an inspection contingency written into them, so that if the home inspection reveals serious problems, the purchaser can back out without penalty. If you didn't put this contingency in your contract, you may lose your earnest money (usually several thousand dollars). If not, the process of negotiating with the seller to have the home repaired or to credit you money at closing in order to handle the repairs yourself, can potentially hold up the purchase process and delay your closing.
5. You get cold feet or the seller backs out. The contract will outline justifiable reasons for either the buyer or seller to back out without penalty, such as not waiving a contingency or not meeting a deadline. However, if you decide, after waiving the contingencies, that you don't want to go through with the purchase (for example, because you found another house you like better), you'll again lose your earnest money. The reasoning here is that the seller should be compensated for the time the home was off the market, which will delay the amount of time it ultimately takes him or her to sell (and which may have financial ramifications for the seller). Conversely, if the seller decides to back out simply because of a change of heart or because a better offer was made, you will have a legal right to collect damages from the seller.
6. Your financing falls through. Savvy buyers don't make offers on homes without getting preapproved - that is, without getting a written loan commitment from a bank that it will provide you with mortgage of a certain amount (and savvy sellers don't accept offers from buyers who aren't preapproved). However, there are things that can prevent the loan from closing, such as if you lied on the application, interest rates increase sharply, your job situation changes or your credit score goes down. Ask your lender how you can avoid problems like these. (To learn more, read Understanding Your Mortgage.)
7. The property is in a high-risk area and you don't want to live with that risk (or pay to insure against it). In states that require a natural hazard disclosure report, during escrow you'll receive a document outlining the natural hazards that may affect the home (floods, earthquakes, seismic hazards and fires, for example). The lender may require that you purchase hazard insurance (above and beyond your homeowners insurance), if the home is in a high-risk area, and that insurance can be expensive. It's also a cost you'll be required to pay every month until the loan is paid off, or when you sell the house. To prevent unpleasant surprises during escrow, ask your agent, neighbors, and/or the city planning department, when you first start looking for a home, which natural hazards exist in your desired area, what type of extra insurance you might have to buy, and how much it might cost.
8. The home isn't insurable. If a previous homeowner has made a major insurance claim on the home, such as water damage or a mold claim, this will show up in insurance records, and insurance companies may refuse to insure the home, thinking that it is too much of a risk. If a home is not insurable, you will not be able to buy it unless you are an all-cash buyer, as lenders require you to maintain homeowners insurance until the mortgage is fully paid off. Of course, even if you are a cash buyer, it probably isn't a good idea to buy an uninsurable home. (For further reading, see Will Filing An Insurance Claim Raise Your Rates?)
9. There are costly differences between your good faith estimate and HUD-1. When you get your loan preapproval, and again when you put an offer on a specific property, your lender should give you a good faith estimate detailing the closing costs associated with obtaining financing on the home. The good faith estimate is basically a rough draft of what the HUD-1 form you will receive at least 24 hours before closing will show. As its name implies, the good faith estimate should be a close approximation of what you will actually end up paying - ideally within 10% - but some unscrupulous lenders will try to reel in clients with unrealistically-low estimates. If this happens, and you can't get the lender to back down on the excessive charges, your best option may be to ask the seller to extend the closing date and try to rapidly secure alternate financing so you can still buy the house without getting ripped off. (Learn more in Understanding Your Mortgage.)
10. Errors prevent closing on time. There are many different parties involved in closing escrow, and if any one of them makes a mistake, your closing can be delayed. Depending on what your purchase contract stipulates and whose fault the delay is, if you don't close on time, you may have to pay the seller a penalty for every day that the closing is late. The seller could also refuse to extend the closing date and the whole deal could fall through. In a best-case scenario, the seller could simply agree to extend the closing date with no penalty. After all, if the deal doesn't close, the seller will have to start all over again, too.
Training for a Successful Finish
Transferring ownership of a home is stressful for all parties. Lots of things have to get done in a short period of time, and there can be major ramifications if anything falls through. The process can be especially stressful for buyers, who must go through a complex, sometimes unfamiliar process and make a multitude of weighty decisions related to what is probably the most expensive purchase of their lives. Take some time to familiarize yourself with the escrow process and its potential pitfalls well in advance, and you'll be emotionally, intellectually and financially prepared to finish the race.