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

 ← Back: Get the disclosureNext: Have the house inspected → 

Making an Offer

If there's a good chance you want to buy the house, then you'll make an offer to the seller.  That means you tell the seller how much you're willing to pay for the house.  (Actually, if either side has a real estate agent, then it's the real estate agent(s) who do the talking.  Sellers and buyers don't talk to each other directly, unless neither of them has an agent.)

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.  The contract usually provides a way for you to back out if you decide you don't want the house after all, 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's 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 seller might reject your offer and give a counteroffer of a price a little higher than yours.  You can agree to that or counteroffer again, offering slightly less.  The process continues until you've either both agreed or neither side will budge, in which case the deal has fallen through.

The Contract

If the seller accepts your offer then you'll both sign a contract.  The contract doesn't necessarily obligate you to buy the house no matter what—more on this in a minute.   After you sign the contract the seller will 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.

In most cases you'll use the standard contract form for your state.  Visit your state real estate commission website now and get a copy of the form so you can follow along.  (For example, here are the contracts for Texas.)  If the unlikely event the seller wants to use a custom-written contract, try to get them to use the standard form.  If they won't, then hire an attorney to review the contract to make sure there's no hidden surprises.  You don't need a lawyer if it the contract is a standard form, but you can certainly use one if you like.

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.

Protection against buying a lemon house

You might be wary of signing a contract before the house is inspected and you know of any hidden serious problems it might have.  If you're not, you should be.  If you handle the contract properly, you'll have one or more "outs" that let you get out of the contract without being forced to go through with the purchase.  If you're not careful then you could be obligated to buy the house no matter what.  (The seller can't put a gun to your head to make you buy the house if you don't go through with the deal, but if you don't go through you'll likely lose the deposit you'll pay when you sign the contract, and the seller could also sue you for breaching the contract.)

Here are the three possible outs:

1. Option Fee.  You can pay an Option Fee (often ~$250) which gives you the right to walk away for any reason.  This one is pretty much a no-brainer, especially because the contract usually allows you to apply the option fee to the purchase of the house if you go through with it.  (Make sure the "applies to purchase" box is checked on the contract.)  Pay the option fee!  The option to walk away does come with an expiration date (often 5-14 days from signing), and once the option period expires, you no longer have this specific right to walk away.  So, sign the contract, pay the fee, and then immediately have the house inspected so you can find out what, if anything, is wrong with it, to see if you want to bail.  (We'll cover inspections on the next page.)
   
   
2. Specifying repairs in the contract.  The contract will have at least two checkboxes about repairs:  One that says you accept the property "as-is" (no matter what's wrong with it), and one that says the seller has to repair specific things that you write in.  Don't think that you can write in that they have to repair "any and all problems found on the inspection", since most sellers won't agree to that.  My recommendation is that you require the repair of "All problems found on the inspection that will cost at least $X to repair", substituting some number for $X.  Don't nickel-and-dime the seller; your limit should probably be at least $500 to $1000 per repair.  Most houses will need some minor repairs, and they're generally not the seller's responsibility.  Anyway, the seller has no obligation to agree to use your wording, so negotiate carefully.
   
   
3. Lender-required repairs clause.  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.
   
   

Tip: For the love of god, make sure your contract has at least two of the protections listed above!

Earnest Money

When you sign a contract, you'll also pay a deposit called earnest money, usually $500 to $5000, 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 a title company, which is our next topic.

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

Title Company

The title company is the business that does three important things:

1. Holds the earnest money (see the previous section).
2. Issues the title insurance policies (more on this in a minute)
3. Handles all the paperwork related to the closing, including:
1. calculating the amount due from you after all the fees, and preparing a Settlement Statement that shows where all the money's going
2. getting all the signatures from you and the buyer at closing
3. submitting the documents to the local government to officially record the sale

The fees are the last thing you need to worry about.  The last time I bought a house (2013), the title company's fee was $250, and it was paid for by the seller, anyway.

Choosing a title company

In most cases, the selection of the title company isn't terribly important, since most of them do about the same (good) level of work, and their rates are usually pretty similar, and pretty low anyway.  Personally, I've usually just let the agents choose the title companies and never worried about it.  But because it's possible to have problems with the title company, let's talk about title company selection.

First, here are the main problems you could encounter with a bad company:

1. Closing gets delayed because the title company wasn't diligent about coordinating all the paperwork between the various problems.
2. They fail to record the sale with the local government.  This is pretty rare, but it could happen.
3. They go bankrupt and you lose your money (the earnest money, or the purchase price of the house if you wired that to them).  If you're concerned about that, then make sure you're using a solid title company, and/or bring a cashier's check to the closing rather than wiring the money.

In theory, any of the seller, buyer, or lender can choose the title company.  In practice:

1. The lender might insist on a particular title company (because that company has a good record of handling closings accurately and promptly).
2. If the lender doesn't have a preference, then the buyer's agent will usually choose the title company and write them into the contract, often without telling the buyer that they have a choice as to which title company to use.
3. If you're buying without an agent, then the seller's agent will usually choose the title company and write them into the contract.

A choice made by either the lender or an agent is generally safe because most title companies are good, agents generally know which ones (if any) to avoid, and there's no incentive for a lender or agent to steer you to a bad company.  I've usually just let agents and lenders choose the title company, except one time when the seller's agent chose a company so far away they were practically in the next city.  (I called them and got the closing moved to the downtown office of the same company, which was more convenient for both me and the seller.)  If you want to choose the title company yourself, check the usual review sites, like Yelp and AngiesList.

Title policy

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 an "owner's 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.  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 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 over, and I never had to deal with that problem again.

In some states the issuance of a title policy isn't automatic, so make sure your contract says that you get an owner's title policy.  It's inexpensive and it offers real protection.  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 amount of coverage in a title policy is generally the sale price of the house.

There's a checkbox on the contract to indicate whether the buyer or seller pays for the title policy, and that choice generally follows the local custom.

Don't confuse the owner's title policy with the lender's title policy, which protects your bank (even though they might make you pay for it).

Survey

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 might be able to 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 will 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 willing to take the cost of the home warranty off the cost of the house.

Reviewing where we're at now

A lot is happening at this point, so let's review:

• Make an offer  (and maybe counter-offers)
• Sign a contract, verifying that:
• It has the anti-lemon protection discussed above.
• The title company isn't too far away and is acceptable to you.
• It specifies you get an owner's title policy.
• Pay the Option Fee  (making sure the "applies to purchase" box is checked)
• Pay the Earnest Money
  
• Order the survey  (unless the seller has a copy acceptable to the title company)
• Have the house inspected  (covered on the next page...)
  

 ← Back: Get the disclosureNext: Have the house inspected → 

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Last update: February 2014