When buying a home, understanding your contract is one of the most important protections you have to ensure you make an informed decision.
As with everything else about real estate, sales contracts or purchase agreements vary from state to state -- and even by real estate company in some places. Variations in regulations place even greater emphasis on working with professionals with local knowledge.
While the terms used may change from place to place, there are seven common terms that are particularly important for you to understand.
1. Buyer cost sheet. Technically, this sheet is not part of the purchase contract, but it's still important.
A property purchase agreement can range from a few pages to a dozen or more, depending on your location and the complexity of the transaction. Buyers need to focus closely on the buyer cost sheet, sometimes called "cash to close."
The buyer cost sheet -- typically generated by your lender but sometimes given to you by a Realtor -- should include everything you will be responsible for paying when you buy a home.
Items included on a buyer cost sheet may include:
- Inspection fees
- Appraisal fee
- Transfer fees
- Down payment
- Closing costs
- Prepaid items such as prorated property taxes, homeowner's insurance and homeowner's association dues
Steve Yeager, an assistant manager with Weichert Realtors in Upland, Calif., says, "Some of those costs, especially the closing costs, may be paid by the seller after negotiations take place, but buyers need to have the entire cost of the transaction laid out for them to make sure they have the funds to buy the home."
2. Commission authorization. Realtor commissions for both the listing agent and your buyer's agent are negotiable and are generally paid from the proceeds of the sale by the seller.
3. Contingency. A contingency is a clause in a contract that expressly sets the conditions under which the contract can be voided and the deposit returned to the buyer. Morgan Knull, an associate broker with Re/Max Gateway in Washington, D.C., says the most common contingencies are for home financing and a home inspection.
"In the Washington area, contracts also have a contingency based on the review of condominium or homeowner association documents so that buyers can cancel the contract if they are unhappy with the information in the documents," says Knull.
According to Tony Geraci, a broker and owner of Century 21 HomeStar in Highland Heights, Ohio, buyers typically have 30 days after the contract is agreed on to have a signed financing agreement in place from a lender. Home inspections usually must take place within seven business days in Ohio, with any cancellation of the contract or negotiations to take place within three days after the inspection.
Contingencies are negotiable. So if you believe you need more time for an inspection or to obtain financing, you can write that into your offer.
4. Disclosure/disclaimer. Rules vary from state to state about what homeowners need to disclose to potential buyers, but most states require sellers to complete a form that tells buyers what they know about their property.
"In California, sellers must disclose anything that affects the 'value and desirability' of the property," says Yeager, who adds that "California is known as the 'nanny state.'"
California sellers must disclose information such as whether they live:
- In an area prone to fires
- On an earthquake fault zone
- Within hearing of an airport
- In an area with a flood hazard
Geraci says that in Ohio, only sellers who live in the property must disclose anything they know that could impact the buyers' decision to buy.
"Estate sales and investors are not required to disclose what they know," says Geraci. "But I always tell all sellers they should share everything they know with buyers."
5. Earnest money deposit. Buyers usually attach a check for their earnest money deposit to their offer. The check is put into escrow once the contract has been approved by all parties and is used as part of the down payment at settlement.
"The size of the deposit varies according to the size of the down payment, the price point of the property, the neighborhood and local expectations," says Knull.
6. Escrow. Escrow is handled by a title company, an escrow company, an attorney or a real estate broker, depending on local practices. An escrow account includes the buyer's deposit and all the financial portions of the purchase transaction before, during and after the settlement.
"The escrow company will pay off all the liens on the property after settlement and will record the transaction at the local courthouse or county office," says Geraci.
The term escrow also refers to prepaid amounts for homeowner's insurance and property taxes that you pay with your mortgage bill each month. Your lender will keep these funds in an escrow account until the bills are due.
7. Good faith estimate. Like the buyer cost sheet, the good faith estimate technically is not part of the purchase contract, but is still important.
"The good faith estimate has a twofold purpose," says Knull. "It gives buyers a snapshot of their estimated costs for closing services, the down payment and prepaid items like homeowner's association dues, homeowner's insurance and property taxes. In addition, buyers can use the estimate to hold their lenders to the amount promised in certain categories of costs."
Geraci stresses the importance of buyers looking at the good faith estimate as soon as possible so they understand how much they will need at closing.
"Some buyers may see that estimate and realize they need to save more before they can buy a home," says Geraci.
Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.