Dear Ginny: If the house I’d like to purchase doesn’t pass inspection, will the entire transaction be canceled and money refunded?
Oh, if only life (and real estate) were so black-and-white — being a grown-up would be so much easier! Unfortunately, home inspections are not pass-fail. Rather, they are part of your due diligence duties as a responsible home buyer. They give you the information you need to decide whether to proceed with the purchase and/or renegotiate terms with the seller. Your ability to cancel the deal and get your deposit money back is governed by the terms of your contract, and standard practices vary from state to state.
Mindset Management
Before you even begin inspections — in fact, before you start house hunting, cultivate clarity about your position on the condition of your target property. Be introspective about your level of tolerance — if any — for actually doing or managing repairs and upgrades, your ability to fund repairs, and your interest in living in your home while work is being done. Get clear on what I call your Vision of Home — what do you want your daily life to look like after you buy your ideal property? Do you want to spend your spare time throwing sophisticated soirees in your pristine digs or bribing your buddies to pitch in at your painting parties? Do you want to move in to Pottery Barn chic or are you excited at the prospect of working hard to customize your place to your exact specifications. Are you OK with painting and replacing flooring, but not much else, or do your handyman skills put Bob Vila to shame?
Even if you decide that your dream digs will be in move-in condition, you must understand that no property is perfect. The older a property is, the less perfect it is likely to be, though older properties often have compensating factors, like charm and higher-quality materials and workmanship than modern construction. Early on in your house hunt, ask your Realtor to brief you about what the norm is in terms of condition in the neighborhoods, price range and property type you’ll be shopping from. And it’s up to you to brief your Realtor on your level of fixer-friendliness, or lack thereof.
Finally, to get the three basic inspections — pest, property and roof — costs an average of about $700 in a metropolitan market — more for luxury homes. If you have inspections, hate the results and choose to back out of the transaction at a time when you can get your deposit back, you will still be out the cost of inspections. Some buyers are tempted to skimp on inspections for that reason, but that is foolhardy.
The upfront costs of inspection are an investment in avoiding drama and huge expense later. I once had a client who was in contract to buy a home that had been gutted to the studs and rehabbed in its entirety — the windows and appliances still had their tags on! Nevertheless, we ordered a property inspection and were told that two-thirds of the foundation needed to be replaced, which would run about $80,000. For a second opinion, I called a foundation specialist who disagreed with the original inspector — he said the entire foundation needed to be replaced, which he could do for about $90,000, but that to prevent the drainage problems from recurring, a $30,000 drainage system needed to be installed. Had my buyer neglected to have an inspection because everything was new, she would have been signing up for a huge, nasty surprise later on.
Need-to-Knows
In most areas there are very few or no requirements a home must “pass” before it can be legally sold. Where there are, they tend to be very basic requirements, like lead testing, smoke detector installation or water heater strapping to resist earthquakes. (Note that government loans may have additional requirements, like no broken windows, etc.) The real test of a property is whether it “passes” your requirements for condition. Many times, in order to know this, you must collect all your inspection reports, make decisions about what recommended repairs you feel you would need to complete in order to feel comfortable owning the property, and collect bids to determine how much the repairs will cost. From there, you and your Realtor should decide whether to ask the seller to contribute to or complete any repairs, and precisely what to ask for. If the repairs are too major or the inspection report findings too grim, you might elect to simply cancel the deal and look for another property.
This begs the question of whether you can cancel the deal and get your money back if the inspection results don’t meet your approval and you are unwilling or unable to either (a) resolve the condition issues with the seller or (b) to take the property as-is. Different states have different standard practices on this matter, but most fall into two camps: contingency-period states and objection-period states.
If you are in a contingency-period state, like California, you put an earnest money deposit into escrow when your offer was accepted. From the date of acceptance your contract provides a certain number of days (17 days, unless you and the seller agreed otherwise) in which you can remove or exercise your contingencies. Contingencies are just your right to back out of the contract for various reasons — including that the condition of the property is not to your satisfaction. In your contract, you agree that at the end of your contingency period, you will either exercise your contingencies (backing out of the deal) or remove your contingencies (indicating that you plan to move forward and close the deal).
Most California contracts include an agreement that your deposit becomes nonrefundable and goes to the seller if you remove your contingencies and then later bail; in exchange, the seller agrees not to sue you if you breach the contract in this way. However, in a contingency state you must proactively sign a document that formally removes your contingencies for your deposit money to become nonrefundable — if your contingency period expires, and you haven’t removed your contingencies and you decide to bail, you are still legally entitled to get your deposit money back. The flip side is that if your contingency period expires and you don’t remove them, the seller can issue you a 24-hour notice forcing you to either remove them or cancel the deal.
Ideally, though, you will get your inspections and review the reports early on in the contingency period, to give yourself ample time to get repair bids, get your loan underwritten, and have the appraisal completed and reviewed with time to spare. If you are in a contingency state, and you decide to back out of the deal because of negative inspection results before you have removed your contingencies, you are entitled to receive your deposit money back, minus any inspection costs you have incurred.
If you are in an objection state, you have an objection period instead of a contingency period. If you do not make a repair request or back out of the deal within the objection-period time frame, your deposit money automatically becomes nonrefundable. Note that many bank-owned properties are sold under boilerplate contracts that create an objection period, even in contingency states. So, if you are in an objection state, you must make your move and cancel the deal before your objection period runs out, or you will not be able to get your deposit money back.
Action Plan
1. Get clear on how much fixing you are prepared to do or to pay for, before you start house hunting.
2. Communicate this to your Realtor.
3. When you get into contract, get clear on when your contingency or objection period expires. And read your contract and any addenda to be sure you understand how and when you are entitled to cancel the contract and get a deposit refund.
4. Don’t skimp on inspections — attend them and read the reports, collect repair bids, then decide whether you can resolve any condition issues with the seller.
5. If you can’t resolve all condition issues, cancel the deal, but make sure you do it before your contingency or objection period expires to ensure a quick and easy refund of your deposit money.