House hunting can be an exciting process, but it’s not without its share of heartache. Many hopeful homeowners can relate to the experience of falling in love with a house, only to lose out to a competing buyer who can put down a cash offer.
Money matters in house hunting, especially in a hot market. But you can still find other ways to be the most attractive buyer. Doing the right prep work in advance and highlighting other strengths can nudge you ahead, even if a competing buyer is ready to flash some cash.
What Is a Cash Offer?
First off, you might be wondering, did I read that right? There are people ready to buy a home with an all-cash offer?
As of April 2021, one in four buyers made a cash offer on a house. As the name suggests, a cash offer means no mortgage — buyers had the money ready in the bank, or fully funded the home purchase by selling stocks or their current home. Both the buyer and the seller may have good reason to favor this type of arrangement over a sale involving a more typical mortgage agreement (although not always).
What You Need to Know About Buying a House With Cash
Paying for a home with cash offers some competitive advantages. For buyers who can afford it, buying a home with cash means the purchase is one and done. No interest, no monthly payments, instant full equity. The seller doesn’t have to wait 15 or 30 years for a buyer with a mortgage to repay the debt, of course, but processing a mortgage agreement can take up to 60 days to go through. Buyers financing their home also come with greater risk of the deal falling through due to factors like a failed mortgage approval or lack of funds to cover a possible appraisal gap.
While today’s real estate market has a higher-than-usual share of cash buyers, money isn’t the only selling point for a competitive offer. Sellers may be looking for a home sale experience that’s convenient, pleasant, and timely in ways you can capitalize on, even with a mortgage.
How Can I Compete With Cash Home Buyers?
Your best strategy to compete with cash home buyers is to find out what the seller is most hoping to gain out of their home sale. A competitive bid is one factor (and it’s possible that a cash buyer is operating under a hard limit, while another buyer might be willing and able to take on a slightly higher mortgage). Presenting yourself as a prompt, easygoing, and flexible person to work with can also put you ahead of the pack.
Work through this checklist to create the smoothest experience you can for the seller and increase your chances of beating out a cash-only offer:
- Get approved for your mortgage ahead of time
- Use a well-known lender
- Increase your earnest money or good faith deposit
- Consider an appraisal gap guarantee
- Consider an escalation clause
- Waive as many contingencies as possible
- Offer a flexible rent-back to the owners
Not sure how to implement a few of these suggestions? Let’s walk through how to put these tips into practice.
How Do I Get Pre-Approved for a Mortgage?
Getting pre-approved for your mortgage is one of the best ways to trim your closing timeline, since you’ll have the majority of paperwork and underwriting done ahead of time. Pre-approval is a different process than pre-qualification for a mortgage. Pre-qualification doesn’t involve as much documentation or run the credit check yet. With pre-approval, you get a more in-depth review and more accurate statement of how much a lender will offer you for financing.
You can get pre-approved by filling out a mortgage loan application (working with a well-known lender is a good way to boost your and the seller’s confidence). The lender will check your credit with the three major credit bureaus and ask for various forms of paperwork to review your income and assets:
- Pay stubs
- ID documents such as driver’s license
- Two years of tax return and W2 or 1099 documents
- Bank account, retirement account, and other account documentation
The lender underwrites the information and (provided all looks in order) completes pre-approval, meaning you’re clear to sign on for a certain amount in mortgage loan financing. Having pre-approval doesn’t mean you’re legally bound to work with that lender, but the preliminary steps are taken care of, so you can close faster once you have an offer on a home accepted.
What Is Underwriting and How Will It Help Me Compete With Cash Home Buyers?
Underwriting is the process lenders use to review your finance documentation and loan application and assess the risk of lending to you. Many lenders use an automated computer algorithm rather than a human underwriter to complete the process, which helps speed up the timeline.
Taking care of underwriting in advance helps you cut way down on your closing timeline. Cash buyers don’t have to wait for a mortgage agreement to go through, which can be attractive to sellers. By completing your pre-approval and underwriting, you’re back on a similar playing field because you’ve already crossed some time-consuming mortgage steps off your list.
What Is an Escalation Clause?
Money isn’t everything, but we’d be naive to say it isn’t an important factor for sellers. If having financing on your side allows you to outbid an all-cash buyer, that can be the advantage that gets you the deal.
An escalation clause is a way for some buyers to strike a balance between finding a deal and outbidding competitors. Basically, it states that if another buyer makes an offer, you’ll increase your offer by a certain amount up to a cap. For example, your offer is $400,000, but the escalation clause says you’ll beat competing offers by $2,000, up to a cap of $440,000.
Escalation clauses can come in handy, but if multiple buyers have them, things can get complicated fast, which is frustrating for everyone. Your real estate agent can advise whether an escalation clause makes sense in your local market or if it’s better to make your highest offer from the get-go and skip a bewildering exchange of competing clauses.
How Much Should I Put Down in a Good Faith Deposit?
A good faith deposit, or earnest money, is money you put in to show your offer is serious. The good faith deposit goes into an escrow account, not directly to the seller, and if the sale closes, it counts toward your down payment. Lenders may draw from the good faith deposit to cover some expenses like the home appraisal.
In a typical market, the good faith deposit may be about 1-3% of the home’s purchase price. In a highly competitive market, a larger deposit can be a way to demonstrate financial stability and make it clear how serious you are about the house. Terms on good faith deposits can vary — some terms and contingencies can make more of the deposit refundable if the sale doesn’t go through for various reasons — but in many cases, at least a portion of the deposit is nonrefundable because it’s meant to incentivize the seller to take the house off the market, and compensate them for lost opportunity if the sale falls through.
Should I Waive Contingencies?
Contingencies are clauses you build into your offer agreement to protect you if obstacles come up between the offer and closing day. For instance, a financing contingency lets you out of the deal if your mortgage application is unexpectedly rejected. An appraisal contingency could let you renegotiate or cancel the deal if the appraisal comes back low, and a sale contingency could let you off the hook if you’re unable to sell your current home within a certain timeframe.
Contingencies protect buyers, but they add uncertainty for sellers as to whether the sale is really going to proceed. The more contingencies you’re comfortable waiving, the fewer potential roadblocks there are, and the more attractive your offer may be to a seller.
The drawback, of course, is if you waive a contingency, you’re giving up one possible route to getting out of a deal. A low appraisal can leave you with an appraisal gap you’re on the hook to cover, or even put you in a tough spot if your mortgage loan is denied, so talk with your agent about which contingencies to waive and which to keep, so you’re protected while submitting the best offer you can.
A variation on waiving a contingency is extending a flexible rent-back offer to the sellers, which allows them to stay in the house for a short period of time after selling the home. This can be valuable for sellers who need a few days or weeks to find or prepare their next home and move in. Generally, sellers staying in the property pay a pro-rated “rent” to the new owners, but in a competitive market, specifying a rent-free period for sellers to make their last preparations and move out can give your offer an attractive edge. So instead of waiving a contingency (and taking on extra risk), you’re waiving a certain amount of pro-rated money you may otherwise have asked for and giving the sellers some extra time for a stress-free move.
What Is an Appraisal Gap Guarantee?
An appraisal gap guarantee is one possible way to sweeten the deal and make yourself more favorable to sellers, especially in markets where homes are fetching surprisingly high prices. An appraisal gap guarantee is a promise you write into your offer where you commit to paying the difference between a lower appraisal and your offered bid. Often, you specify a cap to how much over the appraised value you’ll pay.
The important risk to keep in mind is that your mortgage lender will base their final financing agreement with you on the appraised value of the property. Let’s say you’re buying a $500,000 home with a 5% down payment and seeking a $475,000 mortgage. The appraisal comes back valuing the house at $480,000, so after the required 5% down, your lender will only offer a maximum $456,000 loan. You’re $19,000 short — that’s the appraisal gap.
You want to be mindful of the potential consequences of adding an appraisal gap guarantee, especially if you’re waiving contingencies, or you could end up owing more at closing than you budgeted for. It’s best to move forward with this strategy only if you are confident you have the cash reserves to cover a potential gap as well as closing costs and required cash reserves.
Get the Most Out of Your Cash
If you can, increasing your down payment or good faith deposit can help convey your seriousness and make you a competitive buyer, even when competing with all cash offers. A financing partner like Noah can help you balance your family’s need for a cash cushion with your best house bid. You can consider a Home Equity sharing agreement, which lets you access home equity value without adding monthly payments to your load. You can also reach out to Noah for help with your down payment. The Down Payment Assistance program provides up to $500,000 to achieve 20% down or more, so you can put up a larger down payment while securing low mortgage rates.
When it comes to house hunting, cash doesn’t have to be king. How you prepare and what you’re willing to offer to smooth the path for sellers can make all the difference in how a home owner views your offer.