Buying a home can feel daunting. It’s exciting to find a place you love, but how do you make sure your dream home isn’t a money pit in disguise?
If you’re getting ready to buy a house, you’re probably hearing all kinds of terms that previously flew right over your head without much thought. One of them is “due diligence,” and it’s something you are being cautioned to do as a first-time homebuyer. But what is due diligence in real estate?
In layman’s terms, due diligence amounts to doing your homework — about your mortgage loan, about the neighborhood, and about the house. Specifically, it refers to a period of time outlined in the purchase agreement during which you have the opportunity to learn everything you can about the house… and to back out of the deal if you learn it isn’t right for you.
Sometimes the “due diligence period” is a specific number of days, and sometimes it lasts until closing, depending on the state where you are buying and what’s in the purchase agreement. No matter how long you have to do your due diligence, there are steps you should take during each part of the homebuying process to make sure you’re buying a house without any hidden issues.
Due diligence before the contract
Due diligence starts at the very beginning of the homebuying process, before you even start looking at property. Here’s how to do your due diligence before you make an offer on a home.
Hire the right help
Once you’ve decided to begin shopping for a home, you’ll likely start looking for a real estate agent. Whether you realize it or not, the agent you choose is the first due diligence decision you make.
“A lot of people don’t realize that the agent you choose is going to be a large determining factor in whether you get the home you love or if you get it for the price and terms you want.”
In addition to hiring a real estate agent, you’ll also want to do your research and see if you need to hire a real estate attorney. Most states do not require real estate attorneys to purchase a house, though a few states do. Your agent should know if your state is one of the few that requires the use of a real estate attorney.
Educate yourself about the market
Before you purchase a home, you want to have a firm understanding of the real estate market. Will you be buying during a seller’s market or a buyer’s market? Understanding the market will help you determine how much you might have to spend to get into your desired neighborhood. You don’t want to overpay for your house, of course, but you also want to make a competitive offer out of the gate so that your offer is considered.
To educate yourself about the market, spend some time looking at homes that are for sale and homes that have recently sold. Pay attention to the list-to-sales-price ratio so you get a sense of whether other buyers are paying more or less than asking price.
Based on what you learn, talk to your agent about where you should focus your search in order to fit your budget. “Look at your whole life,” advises Sweet, in order to determine what you can truly afford.
Educate yourself about the neighborhood
Sweet says that before you even look at houses, it’s important to determine the area of town where you want to buy. “Especially in my area, we are getting a lot of people from out of state, so they’re not as familiar with where the shopping and entertainment are,” says Sweet. “You should know the area a bit. If the prices are the same in two neighborhoods but you’ll shave 15 minutes off your commute, that could really be a determining factor in the home you choose.”
Once you’ve narrowed down the neighborhoods where you might want to live, do some digging to see if you can find out about development and infrastructure projects planned for the area in the future. You might notice that one neighborhood’s master plan calls for light rail expansion or greenway additions, both of which will likely raise property values.
It’s also wise to see if the school system is good and what the crime rates are like. Check to see if there are sex offenders living in the area. Is the neighborhood in a FEMA flood zone? Are housing prices going up, or have they not increased as much as surrounding areas? The more information you can gather about your prospective neighborhoods, the better.
Shop around for your mortgage loan
Now that you’ve found an agent, have a good understanding of the real estate market, and have narrowed down the neighborhood where you’d like to buy, it’s time to shop for a mortgage loan.
Sweet says that you need to do your due diligence in choosing a lender. To find a lender, many homebuyers use a mortgage broker, who acts as a middleman between you and multiple lenders to help you find the competitive mortgage terms and interest rates. A retail loan officer, by contrast, works for one specific lender and can offer you different loan terms from that one lender.
Different lenders will offer you different rates, so it’s important to shop several loans to get the very best deal.
No matter which lender you choose, Sweet advises that you should “always go local.” The reason, explains Sweet, is that local lenders understand the local lending programs and loan types that out-of-town lenders might not know about. “Local lenders have more flexibility because they know the market,” he says.
Sweet also recommends that buyers talk to at least two lenders before choosing one they’ll work with.
“I want lenders to compete for my business,” he says. “I want to know they are going to provide great service and put their best foot forward.”
Ask each lender to provide you with a Loan Estimate, which you should compare. “Any lender should be able to put together a mock statement,” says Sweet. He recommends looking at the interest rate, monthly payment, and upfront charges — some lenders have loan origination fees, for example, while others don’t — and choosing the lender that offers the best terms.
Insuring the house
You will need homeowners insurance; and there are several different types. While securing homeowners insurance isn’t something that you’ll do until closing, investigating prices before you make an offer can really help. The last thing you’d want is to find out that the house of your dreams isn’t insurable or that insurance for the home will be astronomical for some unforeseen reason.
Sweet says that having the right agent will go a long way towards ensuring that you don’t get caught off guard when it comes to insuring your home. “If you get the right agent, they are going to do their due diligence ahead of time,” he says. For example, if the home you are interested in buying is going to require flood insurance, a good agent will know that ahead of time. The good news, says Sweet, is that “getting insurance quotes is relatively easy.”
Regardless, you want to know upfront if the home you are interested in requires supplemental insurance. Is the home in an earthquake or wildfire hazard area? Does the home have a pool and, if so, will you be required to carry additional liability coverage? Make sure you’re clear on the insurance you’ll need to acquire and how much that insurance will cost you.
Make an offer that makes sense
The final step in doing your pre-closing due diligence is to make an offer on the home. You’ll want your offer to be in line with the market, and your agent should help you land on a good number.
Due diligence during closing
Get an inspection
Now that you have the home under contract, it’s time to get a home inspection. The seller is supposed to disclose any known issues with the house, but getting an inspection is a good practice regardless.
Sweet says that he always recommends getting the home inspected, even if it’s new construction, and that the inspector you hire should be “licensed, insured, and bonded.”
He also points out that buyers often overlook re-inspections — that is, making sure the inspector goes back out to the property to ensure the homeowner made all the agreed upon repairs. “If you are having the HVAC cleaned and there are receipts, you don’t need to re-inspect that,” explains Sweet. “But for the major repairs that the homeowner is supposed to have done, you need to make sure that the inspector goes back and confirms that the repairs were completed in the manner that they should be.”
… In fact, get more than one inspection
A basic home inspection looks at the home’s structures and systems, but you might want to go deeper and order other inspections. Here are some additional inspections you may want to consider:
- Radon test
- Sewer scope
- Pest inspection
- Lead-based paint
- Well and septic
Sweet says that the inspections required at each property are different. “That’s something buyers should consult with their agent on,” he says.
In addition to the inspections listed above, anyone purchasing a manufactured home should obtain an engineering certification. “That’s where the foundation of the manufactured home is inspected to ensure it is up to the quality it needs to be,” explains Sweet.
Get an appraisal
If you are getting a mortgage loan to purchase your home, an appraisal will be required so that the bank is assured they aren’t loaning you more money than the home is worth. Even if you are buying a house in cash, it’s good common sense to obtain an appraisal so that you can make sure you aren’t spending more than the home is worth.
If the appraisal comes in lower than the offer you’ve put in on the house, you’ll have an opportunity to renegotiate, so long as your home sale contract included an appraisal contingency.
Review the land survey
Land surveys document the parameters of the property you are buying and outline any easements on the land.
Sweet points out that land surveys aren’t always necessary. In subdivisions, for example, Sweet says that property lines are usually marked and clear. At more rural properties, however, it’s not always clear where the property lines are. “In that case, I’d have a surveyor tag the property line,” says Sweet. “There may also be cases where the property needs to be resurveyed.”
Get title insurance
Title insurance protects the buyer if the title search missed something, such as a lien on the home, that is discovered later. Without title insurance, you’re responsible for cleaning up the mess on your own.
In Idaho, where Sweet works, the seller typically provides the lender’s title insurance. “For the buyers, I recommend the extended policy,” says Sweet. “It covers certain things after you close — like, for example, if there are encroachment issues.”
Extended title insurance is inexpensive and “well worth it,” says Sweet. “It protects the buyer after the closing of the sale to ensure they are going to have no other encumbrances that are found after the fact.”
Ask about warranties
You’ll want to have your real estate agent ask the seller if the home’s systems and major appliances are under warranty. If they aren’t, you can ask the seller to provide a warranty — this is something you might seriously want to consider if the home inspection turns up that the systems or appliances in the home are aging.
Is there an HOA?
Make sure to ask if there is a homeowners association (HOA) in the neighborhood. If there is, you’ll need to understand the HOA fee — which may be significant — and the covenants, conditions and restrictions (CC&Rs).
Review the CC&Rs in great depth, as there may be rules lurking inside that will rule out the house for you. For example, if your kids are set on having a pool or you need a fence for your dog, make sure that the CC&Rs don’t forbid such things.
Due diligence after you close
Have a homeownership plan
Your due diligence shouldn’t end just because you’ve purchased a home! Houses require constant upkeep, and you should create a homeownership plan that not only outlines the regular maintenance that needs to be done on the home, but when it should be done and how you will pay for it.
If you do your due diligence before, during, and after the sale of your home, you can feel good knowing that you’ve done everything you can to care for your investment.
Header Image Source: (Maresa Smith / Death to the Stock Photo)