Real Estate 301: Contracts, Offers & Counteroffers
You finally did it, you found the home of your dreams. Since you’ve already shopped around and pre-qualified, you know that you can afford it and approximately what the payments will be and how much money you’ll need to bring to closing. Now you’re ready to make an offer. Many first time homebuyers have no idea how this is actually done. Often, buyers call in on a property and ask the agent to make a verbal offer to the seller. Usually this is an extremely low, often ridiculous offer, referred to as a “lowball” offer. More on lowball offers later, let’s look at why verbal offers are shunned by agents and sellers. In Texas, offers are formally made by filling out a contract, specifically a One to Four Family Residential Contract (Resale). This contract is a legally binding document (when signed by all parties) and specifies the details of the offer. These forms once were about a page in length but have grown into an 8 page tree killer. Most of the contract is standard legalese and is about as interesting reading as the table of contents of a calculus textbook, in Chinese. Your agent can explain what this lawyer secret code means in general terms but you should ask an attorney for a more detailed explanation.
There are several places in the contract that are what are referred to as negotiable items. These spots on the contract are easy to find because there are either fill-in-the-blank spots or checkboxes or a combination of the two. Some of the blanks are for things like the seller and buyer names, and the address and such but the negotiable ones are the things that the entire deal hinges upon. In a particular real estate market some of these negotiable items are customarily paid for by the buyer and others by the seller but they are still negotiable. These can vary greatly from region to region. For example, in Waco, buyers customarily pay for a survey if their lender requires one (they usually do). Sellers customarily pay for title insurance since they are guaranteeing that they have the right to sell the property (title insurance protects the buyer against ownership claims from third parties). It is important to know the customs of your local market since an offer that is presented asking the seller to pay for something he wasn’t expecting to, may be met with a great deal of resistance. However, other terms of the offer may make the seller more amenable.
Here is a list of the most important negotiable items found in a standard offer:
1. Price – how much the buyer is offering the seller for the property. Obviously this is probably the biggest factor in the entire offer, but all the other negotiable items interact with the price. A “full price” offer can end up not so fully priced if the buyer is asking the seller to concede thousands of dollars elsewhere.2. Financing – how the buyer is planning to pay for the property. Will he be paying cash or borrowing the money. There is a myth that cash offers are better for the seller than financed deals so you can offer a lot less. In the end, this comes down mostly to time to close (see #8). The seller will get a check at closing whether the money was cash or borrowed, so the fact that it’s a cash deal means only that it can close quicker. Now there is a chance that the buyer may not get loan approval, so in that sense a cash deal is safer. Also lenders may require repairs for certain types of loans, sellers need not worry about this on a cash deal. So there are some advantages to a cash deal but to have a large effect on the price it would require other buyer concessions, such as no option period (see #11) and a quick close.
3. Earnest money – earnest money is money that is put down up front as a statement that he is serious about buying the property. This money is held in escrow (usually at a title company or other escrow agency) if all the details of the contract are agreed upon by both parties and is credited towards the price of the property at closing. If the buyer decides to back out of the deal and there is no option period (discussed later), the seller can keep the money.
4. Title Policy – who pays for the title policy and what company will issue it. The price of the policy is based on the sales price and the rates are set by the state, so in Texas all policies cost the same about despite their issuer. The prices for other services that the title company provides may vary however.
5. Survey – who will pay for the survey. Buyers generally pay for these, lately they are running around $425 and up. The contract allows for the buyer to ask the seller to provide any existing survey. If the seller is willing and the bank will accept the survey it can save the buyer some money. If the buyer is paying cash for the property, a survey is generally not required since it is typically the lender that requires one. However, a survey can reveal important details such as a neighbors fence encroaching onto the property – or that a piece of land is not as large as it was represented to be, so a survey is still a good idea even if not required.
6. Repairs – there is a spot on the contract that states that the buyer accepts the property in its current condition, provided that the seller pays for certain specified repairs. This is one of the “biggies” on the offer since a couple of words here can mean thousands of dollars out of the sellers’ pocket.
7. Residential Service Contracts – an entire article could be written about these. The buyer can ask the seller to purchase (or contribute towards the purchase) a service contract. They are often referred to as Home Warranties, though technically that is not correct. They do provide some peace of mind for both buyer and seller as they cover repairs to many (but not all) of the systems in the home, such as central heat and air, plumbing, etc. The buyer should familiarize himself with what is and is not covered. The buyer is required to call the company issuing the warranty for service, they send the repairman and the buyer pays a “co-pay” charge that is usually a fraction of the entire repair bill. In the case of a central heating or AC unit the policy warranty may not cover all the costs but it will certainly cover a big chunk.
8. Closing – when the closing will take place. This is another “biggie” along with price, earnest money and repairs. A quick closing is usually what sellers are looking for – four weeks is fairly standard in Waco.
9. Possession – when the buyer will take possession of the property. There are provisions for renting the property from the sellers prior to closing or even for the seller renting it from the buyer afterwards. Generally this is a bad idea, ideally the buyer will take possession at closing.
10. Settlement expenses – the buyer can ask for the seller to pay a portion of the buyers closing costs, another “biggie”. This is very common practice anymore, and it helps buyers get into homes with very little money out of pocket. What many buyers don’t realize is these deals are usually structured so that they are actually just borrowing the money for these expenses and in the end it will cost them many thousands of dollars in interest. Also, if for some reason the buyer needs to sell the property in the next few years (moving for a job change), they will find that they will not be able to sell the house (after expenses) for what they owe on it.
11. Option period & fee – an entire article could be written on the option period as it is an important “biggie” for the buyer. The option period is a period of time in which the buyer can cancel the contract without any negative legal repercussions. If the buyer terminates the contract during this time, they are entitled to receive their earnest money back. The length of this period is negotiable, 5-10 days is typical, as is the option fee amount. The fee is kept by the sellers if the buyers exercise their option not to buy. Since this period starts when the contract is agreed upon and signed by both parties, effectively the sellers are taking their home off the market for the duration of the option period. The fee is to compensate the sellers if the buyer backs out and generally sellers desire a short period and a high fee. I’ve seen fees ranging from $25 up to $150, depending on the price of the property.
OK, that covers the most important and most haggled over negotiable items on the sales contract. That may seem like a long way to go, but now it should be apparent why a verbal offer is usually pretty meaningless. There are just too many other factors that influence the seller’s bottom line. Additionally, verbal offers aren’t worth the paper they are written on…err, aren’t written on. In Texas, for a contract to be legally binding it must be in writing and signed by all parties. Realtors are required to present any written offers to the sellers, but there is no similar requirement for verbal offers.
There are a lot of so-called experts that advise buyers that their first offer should be a lowball offer to see how motivated the sellers are. Or the lowball offer is seen as a way to get the seller to drop his price by a considerable amount. As someone who has sold his own houses and as a Realtor who has presented many offers to sellers, I can tell you that lowball offers typically have the opposite effect from the intended one. They also have the effect of making the sellers mad. A lowball offer says to the seller: You’re an idiot, your house isn’t worth anywhere near what you think it is, it’s just a piece of crap that I’m willing to take off your hands. Most folks really don’t want to hear this sort of thing, which is why many lowball offers are simply ignored, especially verbal ones.
That is not to say that lowballing doesn’t occasionally work, sometimes the circumstances are just right and the seller agrees or at least counters back where the buyers want to be. So, it can’t hurt to ask, right? Well, sometimes it can. I’ve had sellers tell me, “We won’t sell it to them at ANY price!” Now, when the same buyer brought a more reasonable offer they did look at it and even countered back but I guarantee you that they were a LOT less negotiable than they might have been had the more reasonable offer been made up front. How do you know in advance which way this will go? Well, without a crystal ball, you don’t. But a good agent can point out things that may indicate more negotiable sellers: home on the market a long time, out of town sellers, or home is part of an estate. Still these same factors may be an indication of non-negotiable sellers. The home has been on the market a long time because it’s too high priced and the sellers won’t come down at all. Those out of town sellers may be able to pay two mortgages indefinitely. Children of deceased parents often have an inflated vision of a home’s worth, especially if they grew up there and have fond memories of the house.
So how much should you offer? Your Realtor can pull up recent comparable sales of other similar homes so you can see what it should take to buy it. Also, it helps to look at the ratio of asking price to sales price. If most homes in the area sell for 98% of the asking price and this home is like most of the others, the seller is going to know this too and isn’t likely going to consider an offer of 80%. Your Realtor can advise you on price, and remember the other negotiable items have a big effect on price. You might get away with a lower offer if you don’t ask for any seller concessions on the other negotiable items. Or, if for instance there is no option period.
Once the contract is filled out and signed by the buyer, it is delivered (usually along with a photocopy of the earnest money check) to the listing agent who presents the offer to the seller. The listing agent will hopefully prepare a net sheet that shows the seller how much they can expect to pocket given the terms of the offer they are presenting. If the seller agrees to the terms of the offer, the seller simply signs the contract. Once the buyer’s agent has been informed that the seller has signed the contract, the contract is said to have been “executed”. Woohoo, we have a deal!
Usually it doesn’t go quite that smoothly. Sellers typically find one (or more) items or amounts to which they object. “I’m not paying for their survey!!!” or “They want to put a new roof on? That one’s perfectly good…it’s only 19 years old!” In these cases, the sellers will simply cross out the parts of the contract to which they object and/or change the amounts, and initial any changes they made. For example, the seller might cross out the price offered of $94,000 and write in $99000 and initial it. If the seller makes changes to the contract, typically they will sign it as well, before it is delivered back to the buyer’s agent. The contract is not valid, however, until the buyer initials the changes.
When the seller makes changes to an offer, and sends it back to the buyer, he is said to be making a counteroffer. The buyer is free to agree to the terms offered by the seller or to make changes of his own. In the above example, the buyer might cross out the $99,000 that the seller wrote in and write in $96,500 and initial it. This changing and initialing can be done on any of the negotiable items. The process of countering back and forth continues until an agreement is reached between buyer and seller and both parties have initialed all changes made to the contract. If many changes were made and the offer & counteroffer process went back and forth a few times, the contract often looks like a huge mess, but it is still valid. Once everyone has “signed off” on (i.e. initialed) all the changes and the buyer’s agent is notified the contract is “executed” and the option period begins. The property is now “under contract”. There are many more things to consider regarding the negotiable items when making an offer but that is beyond the scope of this article. Hopefully, now you have a good overview of contracts, offers and counteroffers and how the process flows. Stay tuned for Under Contract and the Option Period.
Bill Patterson
Kelly, REALTORS
WacoHomeSellers.com
There are several places in the contract that are what are referred to as negotiable items. These spots on the contract are easy to find because there are either fill-in-the-blank spots or checkboxes or a combination of the two. Some of the blanks are for things like the seller and buyer names, and the address and such but the negotiable ones are the things that the entire deal hinges upon. In a particular real estate market some of these negotiable items are customarily paid for by the buyer and others by the seller but they are still negotiable. These can vary greatly from region to region. For example, in Waco, buyers customarily pay for a survey if their lender requires one (they usually do). Sellers customarily pay for title insurance since they are guaranteeing that they have the right to sell the property (title insurance protects the buyer against ownership claims from third parties). It is important to know the customs of your local market since an offer that is presented asking the seller to pay for something he wasn’t expecting to, may be met with a great deal of resistance. However, other terms of the offer may make the seller more amenable.
Here is a list of the most important negotiable items found in a standard offer:
1. Price – how much the buyer is offering the seller for the property. Obviously this is probably the biggest factor in the entire offer, but all the other negotiable items interact with the price. A “full price” offer can end up not so fully priced if the buyer is asking the seller to concede thousands of dollars elsewhere.2. Financing – how the buyer is planning to pay for the property. Will he be paying cash or borrowing the money. There is a myth that cash offers are better for the seller than financed deals so you can offer a lot less. In the end, this comes down mostly to time to close (see #8). The seller will get a check at closing whether the money was cash or borrowed, so the fact that it’s a cash deal means only that it can close quicker. Now there is a chance that the buyer may not get loan approval, so in that sense a cash deal is safer. Also lenders may require repairs for certain types of loans, sellers need not worry about this on a cash deal. So there are some advantages to a cash deal but to have a large effect on the price it would require other buyer concessions, such as no option period (see #11) and a quick close.
3. Earnest money – earnest money is money that is put down up front as a statement that he is serious about buying the property. This money is held in escrow (usually at a title company or other escrow agency) if all the details of the contract are agreed upon by both parties and is credited towards the price of the property at closing. If the buyer decides to back out of the deal and there is no option period (discussed later), the seller can keep the money.
4. Title Policy – who pays for the title policy and what company will issue it. The price of the policy is based on the sales price and the rates are set by the state, so in Texas all policies cost the same about despite their issuer. The prices for other services that the title company provides may vary however.
5. Survey – who will pay for the survey. Buyers generally pay for these, lately they are running around $425 and up. The contract allows for the buyer to ask the seller to provide any existing survey. If the seller is willing and the bank will accept the survey it can save the buyer some money. If the buyer is paying cash for the property, a survey is generally not required since it is typically the lender that requires one. However, a survey can reveal important details such as a neighbors fence encroaching onto the property – or that a piece of land is not as large as it was represented to be, so a survey is still a good idea even if not required.
6. Repairs – there is a spot on the contract that states that the buyer accepts the property in its current condition, provided that the seller pays for certain specified repairs. This is one of the “biggies” on the offer since a couple of words here can mean thousands of dollars out of the sellers’ pocket.
7. Residential Service Contracts – an entire article could be written about these. The buyer can ask the seller to purchase (or contribute towards the purchase) a service contract. They are often referred to as Home Warranties, though technically that is not correct. They do provide some peace of mind for both buyer and seller as they cover repairs to many (but not all) of the systems in the home, such as central heat and air, plumbing, etc. The buyer should familiarize himself with what is and is not covered. The buyer is required to call the company issuing the warranty for service, they send the repairman and the buyer pays a “co-pay” charge that is usually a fraction of the entire repair bill. In the case of a central heating or AC unit the policy warranty may not cover all the costs but it will certainly cover a big chunk.
8. Closing – when the closing will take place. This is another “biggie” along with price, earnest money and repairs. A quick closing is usually what sellers are looking for – four weeks is fairly standard in Waco.
9. Possession – when the buyer will take possession of the property. There are provisions for renting the property from the sellers prior to closing or even for the seller renting it from the buyer afterwards. Generally this is a bad idea, ideally the buyer will take possession at closing.
10. Settlement expenses – the buyer can ask for the seller to pay a portion of the buyers closing costs, another “biggie”. This is very common practice anymore, and it helps buyers get into homes with very little money out of pocket. What many buyers don’t realize is these deals are usually structured so that they are actually just borrowing the money for these expenses and in the end it will cost them many thousands of dollars in interest. Also, if for some reason the buyer needs to sell the property in the next few years (moving for a job change), they will find that they will not be able to sell the house (after expenses) for what they owe on it.
11. Option period & fee – an entire article could be written on the option period as it is an important “biggie” for the buyer. The option period is a period of time in which the buyer can cancel the contract without any negative legal repercussions. If the buyer terminates the contract during this time, they are entitled to receive their earnest money back. The length of this period is negotiable, 5-10 days is typical, as is the option fee amount. The fee is kept by the sellers if the buyers exercise their option not to buy. Since this period starts when the contract is agreed upon and signed by both parties, effectively the sellers are taking their home off the market for the duration of the option period. The fee is to compensate the sellers if the buyer backs out and generally sellers desire a short period and a high fee. I’ve seen fees ranging from $25 up to $150, depending on the price of the property.
OK, that covers the most important and most haggled over negotiable items on the sales contract. That may seem like a long way to go, but now it should be apparent why a verbal offer is usually pretty meaningless. There are just too many other factors that influence the seller’s bottom line. Additionally, verbal offers aren’t worth the paper they are written on…err, aren’t written on. In Texas, for a contract to be legally binding it must be in writing and signed by all parties. Realtors are required to present any written offers to the sellers, but there is no similar requirement for verbal offers.
There are a lot of so-called experts that advise buyers that their first offer should be a lowball offer to see how motivated the sellers are. Or the lowball offer is seen as a way to get the seller to drop his price by a considerable amount. As someone who has sold his own houses and as a Realtor who has presented many offers to sellers, I can tell you that lowball offers typically have the opposite effect from the intended one. They also have the effect of making the sellers mad. A lowball offer says to the seller: You’re an idiot, your house isn’t worth anywhere near what you think it is, it’s just a piece of crap that I’m willing to take off your hands. Most folks really don’t want to hear this sort of thing, which is why many lowball offers are simply ignored, especially verbal ones.
That is not to say that lowballing doesn’t occasionally work, sometimes the circumstances are just right and the seller agrees or at least counters back where the buyers want to be. So, it can’t hurt to ask, right? Well, sometimes it can. I’ve had sellers tell me, “We won’t sell it to them at ANY price!” Now, when the same buyer brought a more reasonable offer they did look at it and even countered back but I guarantee you that they were a LOT less negotiable than they might have been had the more reasonable offer been made up front. How do you know in advance which way this will go? Well, without a crystal ball, you don’t. But a good agent can point out things that may indicate more negotiable sellers: home on the market a long time, out of town sellers, or home is part of an estate. Still these same factors may be an indication of non-negotiable sellers. The home has been on the market a long time because it’s too high priced and the sellers won’t come down at all. Those out of town sellers may be able to pay two mortgages indefinitely. Children of deceased parents often have an inflated vision of a home’s worth, especially if they grew up there and have fond memories of the house.
So how much should you offer? Your Realtor can pull up recent comparable sales of other similar homes so you can see what it should take to buy it. Also, it helps to look at the ratio of asking price to sales price. If most homes in the area sell for 98% of the asking price and this home is like most of the others, the seller is going to know this too and isn’t likely going to consider an offer of 80%. Your Realtor can advise you on price, and remember the other negotiable items have a big effect on price. You might get away with a lower offer if you don’t ask for any seller concessions on the other negotiable items. Or, if for instance there is no option period.
Once the contract is filled out and signed by the buyer, it is delivered (usually along with a photocopy of the earnest money check) to the listing agent who presents the offer to the seller. The listing agent will hopefully prepare a net sheet that shows the seller how much they can expect to pocket given the terms of the offer they are presenting. If the seller agrees to the terms of the offer, the seller simply signs the contract. Once the buyer’s agent has been informed that the seller has signed the contract, the contract is said to have been “executed”. Woohoo, we have a deal!
Usually it doesn’t go quite that smoothly. Sellers typically find one (or more) items or amounts to which they object. “I’m not paying for their survey!!!” or “They want to put a new roof on? That one’s perfectly good…it’s only 19 years old!” In these cases, the sellers will simply cross out the parts of the contract to which they object and/or change the amounts, and initial any changes they made. For example, the seller might cross out the price offered of $94,000 and write in $99000 and initial it. If the seller makes changes to the contract, typically they will sign it as well, before it is delivered back to the buyer’s agent. The contract is not valid, however, until the buyer initials the changes.
When the seller makes changes to an offer, and sends it back to the buyer, he is said to be making a counteroffer. The buyer is free to agree to the terms offered by the seller or to make changes of his own. In the above example, the buyer might cross out the $99,000 that the seller wrote in and write in $96,500 and initial it. This changing and initialing can be done on any of the negotiable items. The process of countering back and forth continues until an agreement is reached between buyer and seller and both parties have initialed all changes made to the contract. If many changes were made and the offer & counteroffer process went back and forth a few times, the contract often looks like a huge mess, but it is still valid. Once everyone has “signed off” on (i.e. initialed) all the changes and the buyer’s agent is notified the contract is “executed” and the option period begins. The property is now “under contract”. There are many more things to consider regarding the negotiable items when making an offer but that is beyond the scope of this article. Hopefully, now you have a good overview of contracts, offers and counteroffers and how the process flows. Stay tuned for Under Contract and the Option Period.
Bill Patterson
Kelly, REALTORS
WacoHomeSellers.com
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