Congratulations! You’ve signed a purchase contract and have opened escrow. Now that you (as a seller) have gone through the marketing, showing, staging, and comparing offers or (as a buyer) have seen homes, gotten a loan pre-approval, made your offer, and won the home, it’s time to celebrate – but not too much.
You’re now in contract, but the road ahead isn’t a smooth drive just yet. Below, we’ll go over some common and less common potential speed bumps and roadblocks sellers and buyers may encounter before closing a sale.
Here are the potential roadblocks to know when closing on a home:
Earnest money liquidity
- Once a buyer enters a contract, they are expected to make an earnest money deposit (“EMD”) with escrow, typically within 24 hours of the offer being accepted. This money is what a buyer puts as “skin in the game” for the contract, and they give it up if they walk away from the sale without an agreed-upon contingency. This can be anywhere from 1% to 3% of the purchase price, which can be a significant chunk of change, especially in expensive markets with a high earnest money percentage custom. Buyers should be prepared by having that earnest money liquid and readily available to be wired/deposited. If not, they may find themselves scrambling to free up funds to make the deadline.
Inspection discoveries and negotiations
- In most markets, the buyer’s agent will include an inspection contingency to allow the buyer to get a professional’s report on the home and major systems like the roof or foundation. (Unless you happen to be in certain markets like the San Francisco Bay Area where sellers already order inspections to include in their disclosures.) Inspections may turn up items not previously made apparent and kick off a round of negotiations between the buyers and sellers over repairs by the seller or credits to the buyer who will end up making repairs. Buyers may demand that repairs be completed before close, or exercise their contingency and walk away from the contract with their EMD.
Financing
- While buyers may have a pre-approval in hand, their lenders still need to conduct final underwriting. A pre-approval is based only on a cursory examination of a buyer’s provided financial documents, and is not a guarantee for a loan – the lender will do a more thorough review of the buyers’ finances before providing a loan commitment. Loan approvals can end up falling through for a number of reasons: a low appraisal (see below); a change in credit score; job loss or change in employment; insufficient time at a buyer’s current job/ insufficient work history; self-employment income that the lender may consider too irregular (earned in one or two big instances a year rather than steadily throughout the year); insufficient cash reserves for jumbo loans; undisclosed loans that are found during underwriting, etc. The underwriting process could be quick, or it could take significant amounts of time as the lenders process the documents they request and need to generate. The lenders may end up denying the loan or adjust terms to where the buyers are no longer willing to accept the loan from that lender. Buyers have a couple of options at that point – they can terminate the contract or they can try to find a new lender that will approve a loan on terms they are comfortable with. However, unless the buyers have a loan/financing contingency as part of the purchase contract, they will be giving up their earnest money deposit when they terminate the contract. Even if a buyer is committed to finding a new lender, if they are unable to close within the stated period in the purchase contract (i.e. cannot find a new lender and obtain a loan commitment in time for closing) and did not have a financing contingency, unless they negotiate additional time with the seller to line up a new lender, the seller can just choose to terminate the contract rather than wait and keep the earnest money.
Appraisal
- Lenders will require an appraisal before issuing a loan commitment. Important to note is that mortgage lenders lend against the appraised price, not the purchase price. So for an 80 LTV (20% down) mortgage, a mortgage lender is lending 80% of the appraised value of the home, not 80% of the purchase price. This means that if the appraisal comes back below the sale price, there is a shortfall because the down payment + the loan is less than the purchase price. (For example, a home with a purchase price of $300k is appraised at $270k. The loan is for 20% down, meaning that the loan value is $216k. Even with the 20% of the purchase price the buyer had set aside for down payment -$60k- they are short $24k.) Buyers that encounter this situation will need to make some decisions. They may ask their lender to make an exception, they may decide to cover the difference out of pocket, they may negotiate with the sellers to reduce the sale price to match the appraisal, or they may walk away. However, if they can’t get an exception, and the sellers do not reduce the price to match the appraisal, the only options buyers have are to cover any shortfall or to walk away and lose their EMD unless the contract has an appraisal contingency that lets them walk away with their EMD.
Title, lien, easement, or restricted use issues
- Once escrow opens, the title company has several days to provide a preliminary report/ title commitment, which will include the results of their title search. This document will lay out the legal description of the property and easements (rights by a non-owner to use, come onto, or move across a part of property), as well as any liens or outstanding debts against the property and restrictions on the use of the property. (In CA, sellers already include in their disclosure packets a preliminary report, so issues to close that come from something disclosed in the preliminary report are much less common.) The discovery of any non-customary liens, problematic easements, or certain restrictions may throw a wrench into the transaction, as the buyer may demand that the seller resolve the issues, try to terminate the sale based on the uncovered restrictions, or be denied a loan or have the property be appraised below the purchase price. Customary liens such as property taxes not due yet and standard easements such as the right for a utility provider to access the power pole located on the lot are not issues. However, non-customary liens (such as overdue property taxes that must be paid off before the county will record the transfer of ownership, or a lien held against the property by a contractor who was not paid for their work) and certain problematic easements (such as the right for the public to walk through the back yard, or an easement that would allow a utility company to remove a grove of old-growth trees on the property) can reduce the value of the property. This reduction in value may end up something the buyer will need to assume the costs of clearing, and if they cannot clear it (such as with easements) their lender may reject underwriting of the loan or the appraisal may not match the purchase price.
HOA
- The sale of property that is part of a Homeowners Association (HOA) means that the escrow company will need to contact the HOA to order documents and order the HOA’s demand. This lays out what the seller and buyer will need to pay in order to make the property current on all dues, pay off any transfer fees, and for the HOA to issue a resale certificate. Some HOAs may be able to place a hold on some of the proceeds from the sale unless the seller completes an association inspection to ensure that the property remains compliant with the rules and regulations, and fixes any violations. Beyond the HOA demand, the buyer’s review of association documents such as rules or financial records may cause them to terminate the sale.
Local requirements and regulations
- Depending on the locality, some real estate transactions require a resale inspection (in which a city inspector will check the property to confirm no violations or other issues that will require the seller or buyer to fix). There may also be a requirement to replace the sewer line or to demonstrate that the sewer line was recently replaced, or to fix the sidewalk if it is cracked and uneven, etc. While most sellers will want to get these taken care of before they enter a contract, this isn’t always the case and could become a source of delay.
While not every transaction will have a rocky road, it’s important to be prepared for the potential for a few stops and starts along the way.
If you happen to just be starting out on your home buying journey or are moving cities or states, you may find our research resources helpful:
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