Make an Offer, Sign a Contract,
& Pay Earnest Money

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Making an Offer

If there's a good chance you want to buy the house, then you'll make an offer to the seller. This simply means telling the seller how much you're willing to pay for the house, if you decide to buy it. You can make the offer even if you're not 100% sure you want to buy the house, and even if you're not sure exactly how much you want to pay. Making the offer generally doesn't obligate you to buy the house, especially if the inspection turns up physical problems with the house. (More on this in a minute.)

Your agent can give you guidance about how much to offer. Remember, though, that the agent has two different incentives to inflate the price. First, the higher the sales price, the more commission they make. Second, the more you offer, the more likely the seller will accept your offer, and the agent wants the house to be sold so she can collect her commission. Although you should keep these things in mind, every time I've worked with a agent on buying a home, they've suggested that I offer a bit less than the seller was asking.

If you don't want to hassle with negotiation and you think the house is worth it, you can simply offer the same amount the seller is asking. If you want to try to get a better deal you can offer a little less than the seller wants, or perhaps see if the seller will make some other concession, such as paying part of your closing costs or making some repairs.

You can even offer more than the seller is asking. This is obviously unusual, but it happens in hot markets where houses move really fast. If three different prospective buyers make offers at the same time, obviously the seller will usually choose the highest offer. In cases like this competitive buyers will try to outbid each other to make sure they get the house.

This is what to consider when coming up with your offer:

  1. The advice of your real estate agent. Your agent is a lot more familiar with the market and the process than you are. Even though they have a vested interest in the price being higher, carefully consider what they tell you.

  2. How much the bank is willing to loan. You obviously can't offer more than you can afford, but you should have realized whether a particular house was out of your budget long before it came time to make an offer.

  3. How much the house is worth. We all want to avoid paying more than something is worth, and this is especially true when buying a house that you might want to sell someday. But you might ignore this if #4 is more important to you....

  4. How much you want the house. There is nothing wrong with paying more than a house is worth if you really want the house and you can afford it. If the seller is asking $200k, but your agent and a market analysis suggest the house is worth only $180k, you can certainly pay the $200k anyway if the house is worth that much to you. Of course, even if you are willing to pay the $200k asking price, it usually won't hurt to offer less to try to get a better deal, unless it's a hot housing market where another buyer might outbid you.

    Offering more than market value for a home you really want works best when you don't intend to sell the home any time soon. An overpriced home takes longer to become worth more than what you paid for it, but if you're not selling it then what do you care?

The Contract

The way you make an offer is by signing a contract and paying earnest money. (More on earnest money in a minute.) The contract doesn't necessarily obligate you to buy the house no matter what -- more on this in a minute.

If the seller accepts your offer they'll sign the contract, and then you can proceed with having the house inspected and appraised. If they don't agree then they'll likely make a counter-offer, by preparing a new contract with different terms that they ask you to sign. The process repeats until you either have a contract signed by both parties, or the deal falls through because the two parties couldn't agree. We'll cover contract negotiations on the next page,

If the seller accepts your contract s/he'll take the house off the market. Then you won't have to worry about competing buyers while you have the house inspected and appraised to make sure it's really worth what you think it is. This secures your position as first in line to buy the house.

Get a copy of a standard contract right now so you can see what's in it and follow along easily. You can likely get a copy from the real estate commission website for your state. (For example, here are the contracts for Texas.) The seller's agent will most likely use the standard contract used in the state you're in. If they've written their own contract from scratch, then get your agent or an attorney to look at it to make sure there's nothing unreasonably disadvantageous to you in it.

If you're using a real estate agent, one of their jobs is to guide you through the contract.  Whether you have an agent or not, the rest of this page will explain the most important parts of the contract.  Incidentally, it's rare to engage a lawyer to review the contract (I never have), but you're certainly welcome to do so if it would make you feel more comfortable.

Earnest Money

When you make an offer by signing a contract, you'll also pay a deposit called earnest money, usually $500 or $1000, to show that you're serious about wanting to buy the house.  The earnest money is applied towards the purchase price if the deal goes through.  If the deal doesn't go through then you can generally get your earnest money back, though this depends on how the contract is worded.  If you default on the contract (for example, by not having the house inspected in the timeframe specified in the contract), then you can lose the earnest money.

The earnest money is held in escrow by independent third party, usually the title company, which is the business that will handle the paperwork for the sale.  Either the buyer or seller can choose the title company.  Personally I've never paid much attention to the choice of title company, but others such as Zillow and Sandy Gadow think you should be careful.

Tip: Once you sign the contract, make sure to have the inspection, survey, and appraisal performed quickly, or you can lose your earnest money. These items are explained on the pages that follow.

Title policy & Survey

Title basically refers to your rights as an owner to a piece of property.  If you own a house, you have its title.  Title insurance (aka a "title policy") protects your ownership against claims that others might make against it, and against errors in recorded documents.  For example:

  • The previous owner didn't pay their property taxes.
  • An ex-spouse of the owner claims an interest in the property.
  • A previous owner didn't pay a contractor for some work they did on the house.

In each of these cases the aggrieved party can make a claim on your house, and in some cases, take ownership away from you. Your title policy protects you against that happening.  The title company that issues the policy first checks to make sure there are no existing claims against the house before you buy it.  (As we saw earlier, they're also the business that handles all the paperwork at closing, which is also when you'll receive a copy of the title policy.)  After you buy your house, if someone makes a claim against it from an incident dating back before you bought it, just call up the title insurance company and they'll take care of it.  Months after I bought my first home this happened to me:  A plumbing contractor threatened to make a claim on the house because the previous owner didn't pay him for work he'd done on the house.  I called up my title company and they took care of it.

The seller typically pays for the title policy.  (The contract allows you to check that either the buyer or seller will pay.)  The amount of coverage in a title policy is generally the sales price of the house.  The cost of the policy is around 0.7% of the house price.  A title policy lasts forever (or until you sell the house).

The title company (and your lender) will require that you have a survey of the property, which is an official drawing indicating property lines and dimensions of the house.  You can probably get this from the seller, who should have a copy of the survey from when they bought the house, but if it's rather dated then the title company might require that a new survey be done.  A survey runs around $400, and you might be able to have it be part of the closing costs that you pay at closing, rather than having to pay it up front.

Residential Service Contract (aka "Home Warranty")

You might be surprised that just like you can get a warranty for a TV, you can get one for a house.  A company will promise to repair electrical, plumbing, and heating/cooling problems for an annual fee ($300-600) and a per-incident house-call fee ($50-60).

Or so they claim.  As you might suspect, many such companies find a way to say that whatever problem you have, it isn't covered by your service agreement.  And the local contractors they send to do the job might not be especially professional or even competent.  The home warranty industry has absolutely terrible ratings from consumers in general.

So how does this relate to the contract?  Well, there's a place on the contract where you can check whether the seller will reimburse you for a service contract that you might buy.  Some sellers buy the service contract to make the buyer more confident about buying the house, especially in the case of first-time homebuyers.  But the inspection should have given you a great idea of the condition of the house, and you should expect to have to pay basic maintenance for your home's upkeep.  I'm not a big fan of service contracts.  If the seller offered to pay for one for you, I'd see if instead the seller would be able to take the cost of the the contract off the cost of the house.

Protection against a lemon house

Potential buyers might wonder why they're making an offer on a house before they even know what physical problems the house might have, which will be revealed during an inspection? The answer is that the contract will either allow you to walk away if significant problems are found, or will require the seller to fix them.

The standard Texas contract (and probably those of many other states) says that the buyer can back out if lender-required repairs exceed 5% of the purchase price. (e.g., $10k on a $200k house)  Your lender doesn't want to loan money on a building that's in bad condition, and may require that certain things be fixed.

You'll also choose one of two options on the contract to protect you. Make sure your contract has one of these two options:

  • You'll either pay an Option Fee (often ~$250) which gives you the right to walk away for any reason, or,

  • You'll indicate on the contract that the seller will be responsible for making repairs to problems found on the inspection.

Let's look at those in more detail:

Option Fee. If you pay an Option Fee directly to the seller (often around $250), you get the right to walk away from the deal for any reason at all, within a certain period of time (usually 5 days to 2 weeks). This allows you to get out of the contract if the inspection shows that the house is in much worse condition than you thought. If you do buy the house, the Option Fee is usually applied towards the purchase. (Make sure that box is checked on the contract.) Remember that the option period is usually short, so if you don't want the house, don't delay in giving written notice that you want out, otherwise you'll be stuck with having to buy the house. If you walk away after the option period, you'll lose your Earnest Money covered below.

Seller-made Repairs. If you don't pay an Option Fee, then you'll want to write into the contract which repairs you want the seller to agree to make. The catch is, you often won't know what repairs will need to be made at the time you sign the contract, because you haven't had the inspection done yet. You might get the seller to agree to repair "Any individual item found on the inspection which would cost $500 or more to have repaired by a licensed contractor." Of course, the seller is not obligated to agree to include that in the contract.

Tip: Make certain the contract contains one of these two protections. If you don't understand the contract, ask your agent. If your agent seems clueless, get another agent, or pay a lawyer to look at the contract.

Amount spent so far.   Red items apply towards the purchase. Amounts are typical, not exact.

$40

Credit Check

To the Lender

$150

Option Fee

Paid to the Seller. Might apply towards purchase, depending on contract. Allows you to walk away for any reason.

$1000

Earnest Money

Held in Escrow, probably by the Title company

$1190

Total

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