by Marti Kilby
Statewide Buyer and Seller Advisory (SBSA)—A comprehensive list of all conditions that both buyers and sellers should consider investigating in the course of the transaction.
Buyer’s Inspection Advisory (BIA)—A list of conditions the buyer is advised to investigate as part of their due diligence during the inspection period.
Market Condition Advisory (MCA)—Advises both buyers and sellers that no guarantees are made regarding the future value of the property, as real estate markets can change.
Megan’s Law Database Disclosure (DBD)—Advises buyers and sellers that through a website maintained by the Department of Justice they may obtain information about the address or residence community and zip code of registered sex offenders.
What to Look for in Reading Real Estate Disclosures
Disclosures should always be read in their entirety. These are legal documents and, by signing, you are stating that you have read and understood everything that is disclosed in a particular document. If you don’t understand, or need clarification on a certain item, please discuss this with your agent before signing. With that said, here are a few key items you’ll want to make sure you’ve reviewed thoroughly:
In the NHD report, make sure to note if you are in a special flood zone, as this may mean that you will need flood insurance. Likewise, if you are in a fire danger zone, it might be more difficult or costly to obtain your homeowner’s insurance. And if you are in an earthquake hazard zone, earthquake insurance may be something to consider. It is also important to notice if you are in an airport flight path or in an area with commercial/industrial zoning, as these influences may cause noise or other disturbances.
On the SPQ and TDS, or on any disclosure form completed by the sellers, if any of the “yes” boxes are checked, there needs to be an explanation written directly below that block of questions or noted on an attached sheet if necessary. Depending on the situation, you may want to request receipts, inspection reports, or invoices to see exactly how repairs, if applicable, were made.
What to Do with a Negative Discovery
It is sometimes the case in the course of reviewing disclosures that you’ll discover a condition or issue you were unaware of at the time you wrote your offer. So, for instance, in the story I mentioned at the top of the chapter, if the proximity of the motorcycle track had been disclosed, the buyers would have had the opportunity to pull out of the deal, provided this was within their contingency period, or they might have negotiated a lower price. In another example, let’s say the seller discloses that the insulation around some of the duct work contains asbestos. It is unlikely the buyer would know this at the time of writing an offer, and while undisturbed asbestos may not be an immediate health concern, it would be in the future should the duct work need repair or replacement. Looking ahead to that possibility may prompt the buyer to ask for a price reduction to help cover the future cost of removing the asbestos-containing materials.
Another situation I’ve observed is when a homeowner discloses a past problem, such as a roof leak, but then notes he or she fixed it themselves. Many home repairs can be accomplished by the homeowner, but in a situation like this, you may want to request that the homeowner provide an inspection of the repairs by a licensed professional, just to make sure the problem was indeed fixed and the work was done to code.
While the seller is responsible for providing complete disclosure about all known facts about a property, the buyer bears the responsibility of making sure they are satisfied with all explanations and that they thoroughly understand the implications of all items disclosed. The best time to ask questions is before you close escrow and purchase a potential problem.
Savvy Shopper Tips: Read through all disclosures carefully before signing. These are legal documents. If you have any questions about a condition on the property or any item disclosed, your inspection contingency period is the time to request a thorough explanation. If problems are disclosed, it may be an opportunity to renegotiate the price, or get out of the deal entirely.
Chapter 16
When the Appraisal Brings a Surprise
As part of the loan-approval process, your lender will hire a licensed appraiser to view your future home, research the neighborhood, check comparable listings and sales, and assign a value to the home. The lender, of course, wants to make sure the amount they are lending would be recouped if you, the borrower, defaults and they have to foreclose. But what happens when the appraisal packs an unexpected blow to your deal? That’s exactly what happened to my clients Mark and Rhonda. Let’s take a look at their story.
Mark and Rhonda fell in love with a family-perfect, single-story home in the North County area of San Diego. It had everything they were looking for; 4 bedrooms, 2 baths and a large lot full of native oak trees in a quiet area with other well-maintained custom homes. The only problem was the price. At $643,000, it seemed greatly overpriced when I showed them the comps, which perhaps explained why it had been on the market so long.
My clients wrote a significantly lower offer at $612,000, which was countered at $635,000. According to the listing agent, the sellers could not afford to budge a dollar below that number, as they had overextended themselves in 2005 with a second mortgage. Even at $635,000, the sellers would have to bring money to the table to close. They had investigated the possibility of a short sale but did not qualify, so this was their only hope.
Looking at the comps, I was very nervous about getting an appraised value of $635,000, and sure enough, the appraisal came in at $625,000—$10,000 off. The listing agent and I tried to challenge the value, but there simply weren’t the comps to support it. As the sellers couldn’t come down in price (since they needed to pay off two mortgages), the only options available to my buyers were to pay the extra $10,000 out of pocket or walk away. Tough decision. If it had been a lesser amount, maybe $5,000 or less, they would have paid it and considered it a premium to get the house they so dearly wanted. But at $10,000 out of pocket, it just didn’t make financial sense to overpay so much, so they walked away.
Appraisal Types
First, it’s important to understand that not all appraisals look at exactly the same thing. The type of appraisal performed will vary according to the type of loan you are getting. Thus, a VA or FHA appraisal will differ from a conventional appraisal in terms of what is inspected, the types of forms that are used, and the qualifications of the appraiser. While the value should be close regardless of the type of appraisal that’s performed, there are some important differences to understand.
A conventional appraisal is based on establishing the actual value of the home, generally using the comparable sales method. The appraiser researches comparable active and sold listings that are geographically and characteristically as close as possible to your home. Value is then added or subtracted from each property for items—such as a forest view versus a truck terminal view, or an updated home versus a home showing deferred maintenance—ultimately arriving at a fair market value.
On the other hand, VA and FHA appraisals not only focus on establishing market value according to comparable sales, they also inspect the home according to certain property condition criteria. As both of these types of loans are government backed, both agencies want to make sure the homes are safe, sanitary, and structurally sound. So, when performing a VA or FHA appraisal, the appraiser will note things about the home that do not meet the VA Minimum Property Requirements or FHA criteria, such as obvious termite damage, lack of floor coverings, leaking plumbing, or no home heating. These items will be called out in the report and must be fixed and re-inspected prior to the lender funding the VA or FHA loan. This is why homes that are being sold “as-is” are difficult to purchase with a VA or FHA loan.
Subject to Repair
Let’s say you’ve just received your FHA appraisal back from your lender, and, unfortunately, the appraiser has called out several items that need repair. For example, if the necessary repairs include tenting the home for termites
, fixing some cracked windows, and tightening the banister, the repairs could easily run close to $4000! The home’s value meets the sales price, but the appraised value is “subject to” the repairs being completed. What to do now?
You basically have three options if you want to move forward with the purchase and you can’t do a conventional loan: 1) Ask the seller to pay out of pocket to fix the repair items; 2) Ask the seller to lower the sales price or provide a credit at closing, and you agree to complete the repairs; or 3) Find a contractor to do the repairs who’s willing to be paid out of escrow at closing. The first choice is the simplest, while the second choice can be a bit problematic and risky. As you remember, repairs must be made before the lender will agree to fund the loan. This means that you, the buyer, could be spending thousands of dollars on repairs on a home you don’t yet own! If all other contingencies are removed and the loan is otherwise fully approved, it is probably okay, but you should also be aware of any worker liability issues and who would be responsible. Also, if this were a VA loan, there may be repairs the buyer is not allowed to pay. This varies by state, so it is a good idea to know in advance of obtaining a VA loan. And while finding a contractor willing to be paid out of escrow is certainly an option, they will usually ask for a credit card for security in case escrow fails to close.
If you’re purchasing a short sale or REO, it is highly unlikely the short-sale lender or bank will pay for any repairs (see Chapter 8), so you’re probably on your own in terms of making any necessary repairs. If you have already completed your home inspection, as mentioned in Chapter 14, you should already be aware of many of these issues, as a home inspection is always more thorough than an appraisal. So, by the time you get to the appraisal, you will have hopefully figured out a way to resolve any repair issues.
Value Too Low
In a market with low inventory, we often see prices driven up by competitive bidding. However, just because you’re willing to pay more to purchase a particular property, it doesn’t mean that an appraiser will value the home as highly as you do. A lower valuation means that the bank is not going to lend you as much money. For instance, if you’re purchasing a $510,000 home with a 20% down payment, you’ll need a loan of $408,000. If the appraisal comes in at $501,000, the bank will only lend you $400,800, which means you are $7,200 short to make the deal work at $510,000.
Low appraised value can happen in a market where there are not many current sales, so the sold prices for comparable properties might reflect a fair market value from several months ago. The fact that you are willing to pay a higher price due to competition still makes it difficult to assign a higher value if there are no comps to support it.
So what can you do? Start with having your agent challenge the appraisal. They can do this by hopefully finding comps that better support the sales price and submitting them through your lender to the appraiser. If your comps are strong, there’s a chance the appraiser will consider a price adjustment.
But don’t count on it. It’s more likely they will stick to their original valuation; in which case, here are your choices: 1) Accept the lower valuation and pay the difference out of pocket; 2) Ask the seller to carry back a small second mortgage; or 3) Ask the seller to reduce the price. Obviously, asking the seller to reduce the price is your most favorable solution, but if it is a hot property with multiple offers, and if the appraised price isn’t ridiculously lower, there’s a good chance the seller will expect the buyer to make up the difference out of pocket. It should also be noted that if the seller takes back a small second mortgage, the monthly payment on that lien will count against your debt-to-income ratio, which may impact your ability to qualify for the first mortgage.
One note here about the VA/FHA Amendatory Clause: If you are getting a VA or FHA loan, this document ensures that you don’t have to go through with the purchase if the appraised value is less than the contract sales price, basically letting you off the hook without losing your earnest money deposit. But even if you’re using conventional financing, it is likely you will not have to complete the purchase if the appraised value is low, as most contracts have a provision that makes the purchase contingent upon the appraisal.
Savvy Shopper Tips: If you’re financing your purchase, make sure the purchase offer reads that the sale is contingent upon the property appraising at sales price or higher. Do not expect to use FHA or VA financing on a home that obviously needs major repairs—at minimum, it must be habitable. Don’t be afraid to challenge a low appraisal if your real estate agent thinks they can make a case for a higher valuation. A bidding war or higher-than-asking-price offer may be a good strategy on a financed deal if you really love the home. This may help get your offer accepted, and you do have options if the appraisal comes in lower than contract price. Paying a reasonable out-of-pocket premium to get the house you want may be worth it, especially if you plan on owning the home for a number of years, during which time the home will hopefully appreciate.
Chapter 17
What Insurance Do You Really Need When Purchasing a Home?
Buying a home is likely the single largest purchase you will make, and it’s therefore important to protect your investment by insuring it against loss. But what type of insurance do you need, and how do you find a good, yet affordable, policy? In this chapter, I take you through the various types of insurance and answer the most common questions I hear from home buyers.
Homeowner’s Insurance
The primary type of insurance you will need is homeowner’s or hazard insurance. This type of insurance comes in several forms, depending on the type of property and the perils covered. Thus, the insurance needed for a condo or townhome will differ from the policy needed for a single-family detached home. A homeowner’s policy covers various protections for losses to the property itself, personal property, and liability for accidents that might occur on the property. When purchasing a condo, the HOA generally has a master policy that covers the actual structure of your home, but it does not cover anything on the interior, such as cabinets or flooring, or personal property. Those items will need to be covered in a separate homeowner’s policy that you, as the buyer, purchase.
The cost of your insurance will be based on a number of factors, including the cost to rebuild the house in case of destruction (replacement cost), the location of the property, the amount of coverage and deductibles, and factors such as having a security or fire sprinkler system, which might qualify for a discount. For instance, a home that is situated on the edge of a brush-filled canyon will likely pay a higher premium than a home that does not abut open space, as the risk of fire is greater.
When selecting a policy, it is important to understand exactly what is covered, and what is not covered. The most common type of policy will include perils—such as fire, lightning, burst pipes, vandalism, civil riot, theft, and falling objects, to name a few—but it does not cover against flood or earthquakes. Personal property will also be covered up to a certain amount, usually 50% of total coverage. But it is important to note there are limits on jewelry, artwork, cameras, firearms, stamp collections, and other valuables. With that said, I’d like to share a story.
Several years ago, one of my REALTOR friends told me a story about her friend Diane. Diane and her husband attended a very dressy New Year’s Eve party to which she wore what had been her mother’s diamond necklace. The necklace contained one beautiful 1.2 carat diamond and two smaller .5 carat diamonds. The necklace had been appraised at $15,000 at the time Diane inherited it from her mother in 2010.
Normally, Diane kept the necklace locked away in the safe in their home, but she was tired when they got home from the party and slipped it into the top drawer of her dresser, figuring that she would store it properly in the morning.
New Year’s Day brought a headache and a reminder from her husband they were expected at a friend’s house on the other side of town for an afternoon of football and food. Diane pulled herself together and left with her husband for another
round of partying with friends, totally forgetting about locking away the necklace.
The couple returned later that evening to discover that, in their haste to leave earlier, they had neglected to set the alarm and someone had broken into their house from the rear entrance. The home was torn apart and cameras, computers, and TVs were gone, as were several expensive handbags…and the diamond necklace.
Diane was devastated. The necklace meant so much to her! But she was even more upset when she learned that their homeowner’s policy only covered up to $1,500 on jewelry loss.
As this story illustrates, if you have valuables that exceed the personal property limits of your insurance, they should be insured separately on what is known as a rider. The amount you will pay extra to insure individual items will depend on their value as appraised by a qualified specialist. Your insurance agent will let you know the requirements for assigning value, depending on whether the insured items are jewelry, artwork, or other valuables.
If you are purchasing the home with a loan, the lender will require they be named as loss payee on the policy and will generally require the first year’s premium to be paid upfront through escrow. If you are establishing an impound account to pay your taxes and insurance with your mortgage payment, the lender will additionally require a deposit of 2 to 3 months’ insurance payments to establish the account.
Shopping for Homeowner’s Insurance
One of the first places to begin shopping for homeowner’s insurance is with the company that carries your automobile policy, as most large companies will provide a multiple-policy discount. These days, it is relatively easy to get several quotes, as you can search and complete requests for quotes online. Before you sit down at your computer, however, make sure you are prepared with information about the home you are purchasing, including square footage, age, type and age of roof, location of the nearest fire hydrant, and any special preventative features, such as fire sprinklers or a security system. It is also important to know if your home falls within a flood zone, as this might mean you will need additional flood insurance as well.
