Your Guide to Real Estate Contracts
At its core, a real estate contract is a crucial element in the realm of property transactions. This written document, which outlines the specific terms and conditions agreed to by both the buyer and the seller, is not merely a formality; it is a legally binding agreement that is essential to ensuring the smooth transfer of property ownership from one party to another. In essence, it acts as the foundation upon which both parties manage their expectations and obligations regarding the sale or lease of a property.
The purpose of a real estate contract is to provide clarity and security to all parties involved in the property transaction. It lays out the what, when, why, and how of the sale or leasing process, from the sale price to the date of closing. By having a contract in place, both the buyer and seller can refer back to the agreement if any misunderstandings or disputes arise , thus potentially saving a great deal of time and resources.
A critical tool within real estate contracts are contract clauses, which are essentially provisions, sections of the agreement that are designed to address specific issues or scenarios related to the sale of a property. These clauses serve a fundamental role in property transactions as they are specifically designed to address potential contingencies, such as the buyer’s need to secure financing or a passing inspection. They can also outline specific rights and responsibilities of each party during the duration of the contract. By including these types of clauses in a real estate contract, both the buyer and the seller are protected in the event that unforeseen issues or circumstances arise during the property transaction.
Standard Clauses in Real Estate Contracts
There are several key clauses that you will find in most real estate contracts. Below is a description of some of the most common and their significance to the contract as a whole.
Earnest Money Deposit: This is one of the most common clauses, present in almost every contract. The earnest money deposit shows that the buyer is serious about purchasing the property and is essentially a "good faith" deposit. The seller may keep this deposit if the buyer backs out of the contract without good cause.
Financing Contingency: Sellers want to see that a buyer is able to finance the purchase before proceeding with a sale. Most contracts have a financing contingency clause, meaning that the sale is contingent upon the buyer’s ability to obtain loan approval and financing based on certain criteria. This protects the seller from wasting time and gives them an out if a buyer does not fulfill this requirement.
Inspection Contingency: In most cases, a house will be inspected before closing. In fact, the contract is often contingent on the inspection being satisfactory to the buyer or seller. Many buyers will list conditions that will cause the sale to terminate if the inspection reports excessive damage or concerns. This clause protects the buyer from having to buy a home in disrepair.
The Importance of Contingency Clauses
Contingency clauses are terms added to real estate purchase contracts, outlining a specific condition needed for the sale to become final. Normally, if the buyer does not meet the condition, he or she can break the contract without penalty. Although there are different types of contingency clauses, they all serve to protect the buyer to some extent.
Some of the most common clauses include:
Home inspection clause
A home inspection contingency allows the buyer to have the home inspected by a qualified inspector before the sale goes through. If something is wrong with the home, the buyer can negotiate repairs with the seller or cancel the sale completely. The buyer will likely be responsible for paying for the home inspection.
Appraisal clause
The appraisal contingency calls for the house to be appraised by a qualified appraiser. The appraisal verifies the value of the home and ensures that the seller is not trying to sell the home for more than it’s worth. If the appraisal comes back and is significantly lower than the purchase price, the buyer is given the option to negotiate with the seller or back out of the contract. The buyer will be responsible for paying for the appraisal.
Loan contingency
A loan contingency is a period of time stipulated in the contact for the buyer obtaining financing for the home. If the buyer cannot get financing by this date, he or she can cancel the agreement with no penalties. The buyer is not responsible for hiring an inspector.
Appraisal and loan contingencies are often combined and referred to as a financing letter or mortgage and appraisal period. Since financing falls through sometimes, occasionally a seller can use the appraisal and loan contingency to persuade the buyer to forfeit the deposit without canceling the contract. If the financing hasn’t gone through, the seller may be willing to re-list the property if there was a backup offer.
Addendum
An addendum may be added to the contract for the purpose of stating exceptions, additions, or additional stipulations in the contract between the buyer and the seller. This document may be added before the contract is fully signed or after the original document is signed.
Escape Clauses: Safeguarding Both Parties
Escape clauses are a type of real estate contract clause where a party (or both parties) are granted the right to back out of a deal if a certain condition happens or does not happen before closing. For example, a sale of a home may depend on whether the property successfully passes an inspection. If it does not pass, or if the parties agree that it is unlikely that the closing will take place if the property does not pass an inspection, the parties may agree to an escape clause that allows the buyer to walk away from the deal without penalty (ie., the down payment or other upfront costs) if the property fails the inspection set forth in the escape clause.
Escape clauses can apply to a number of different things and provide buyers and sellers with an exit strategy in the event that a specific issue arises. In the above example, if an inspection failed on the home, the buyer would be granted the opportunity to walk away from the deal. If the same transaction had an escape clause to protect the sellers from any contingency of financing, this would allow the seller to walk away from the deal if the buyer was unable to secure financing or the financing terms were not acceptable. Escape clauses range in what can be set out, and once they are signed, they will be included in the real estate contracts under the scenario that the conditions are met.
It is worthwhile to note that under some jurisdictions, the laws require the party invoking their right to withdraw from the transaction to provide written notice of their intent to withdraw prior to the scheduled date of closing.
Addendums and Amendments – What You Need to Know
Addenda and amendments are documents which parties may execute to modify existing agreements. These documents are frequently used by parties to amend existing contracts or can be utilized to supplement the deal by adding new provisions. This allows the parties to maintain the original agreement intact but specify any changes the parties would like to incorporate by reference.
Addenda and amendments are often used in real estate transactions. For example, a buyer may wish to reduce its deposit amount , extend its mortgage contingency period, reduce the amount of the deposit to be held by the seller’s attorney, or reduce its due diligence period. The seller may agree to the reduction in deposit on the condition that the buyer indemnifies the seller for any costs incurred in obtaining the release of the deposit from the escrow agent or bank, should the buyer ultimately decide not to proceed with the deal. Common addenda are mortgage waiver letters, estoppel certificates, title waivers, tenant estoppels and lead paint waivers.
Tailoring Clauses to Meet Your Needs
Every buyer and seller has his or her own particular needs, and those needs should be reflected in the contract provisions they ultimately sign. Home inspectors and contractors, for example, may suggest additional clauses for work that must be undertaken. Investors should have clauses ensuring a minimum return on the deal, especially when selling to other investors. Buyers of a pre-construction property, especially one being built by a developer (rather than a custom home builder), should include clauses to protect them from delays in completion and ensure they will be compensated for losses in case of a breach. Plus, as previously mentioned, certain contractual provisions may simply be unacceptable to certain buyers or sellers.
There are a number of ways that buyers and sellers can go about negotiating and crafting their contracts. In most situations, it’s sufficient to simply begin by expressing your needs and desires to your real estate agent or solicitor. They will then prepare an offer that reflects those as well as the feedback they receive from the other side. In most cases, this initial offer will be negotiated back and forth until all of the terms are agreeable. If you’re working with a lawyer, be sure to tell him or her if you have a particular preference for any specific clauses to be included.
Sometimes buyers and sellers find out really late in the process that some express need cannot be incorporated either because the other side is unwilling to agree or because the contract has already been signed and is impossible to renegotiate. It’s best to do your homework ahead of time so you don’t find yourself backed into a corner.
Understanding Common Legal Considerations
Legal considerations related to real estate contract clauses differ from state to state, and may even vary from county to county within the same state. Each state has its own set of rules and regulations known as "land laws". It is extremely important to ensure that any real estate purchase or sale contract you use in your jurisdiction complies with local land laws. Failure to do so can have grave legal and financial consequences.
Examples of some legal pitfalls that may occur with real estate clauses include:
As can be seen from these clauses, any real estate contract must specifically address the particular requirements and laws of the jurisdictions in which the parties live and/or will close the sale. While this is true for typical purchase or sale contracts, other types of contracts governing the sale or purchase of real estate, such as leases, rental agreements, and assignments of real estate contracts, must also conform to local land laws.
As mentioned above, land law may vary not only from state to state but also from county to county. Because of this, it is imperative for the seller and/or buyer to seek the assistance of a legal expert when it comes to drafting, entering into, and executing any real estate transaction (whether it’s in a residential or commercial real estate context). Your legal expert will be able to review your proposed contract to ensure compliance with applicable federal, state, county, and city laws. In addition, your legal expert will be able to advise you as to the various risks and ramifications of entering into a real estate contract. Finally, were any unforeseen consequences to arise, your legal expert is capable of representing you in any resulting legal actions.
Finalizing the Contract
Once a buyer and seller have agreed on the terms of a real estate contract, the next step is to make sure all parties are in full understanding of their obligations. The final version of the contract should be reviewed by both parties to ensure that it contains the provisions that each requires and that is signed by all the required parties.
In a simple sale, the only necessary signatures are those of the Buyer and Seller. Both parties will sign the contract in several places, as well as initialing on the pages of the contract itself. In the case of a realty company or LLC selling or purchasing property, the contract must be signed by whomever is authorized to do so, such as one or more of the members or shareholders.
In addition to the Buyer and Seller, there may be additional signatures required on the transaction from either lenders or third party closers/facilitators. If there is a third party settlement agent, such as a title company or real estate attorney performing a broker’s closing for the Seller, their signature will also be needed . When necessary, space for third party signatures is included at the end of the contract. If a lender is involved, their representative will also need to sign.
The contract will also contain several exhibits, some of which have to be completed and initialed by the Buyer and/or Seller, depending on whose responsibility is to provide that information, such as a home inspection report. Additional forms may include lead paint disclosures and surveys. All the parties must read each document carefully before signing, so no important information is missed, such as whether someone else on the contract has assumed an obligation that the signing party has not yet met.
After the contract is signed, the Buyer will usually provide a deposit for earnest money. A check for the amount of the deposit is usually provided with the contract, but depending on the terms of the contract, it can also be collected when the contract is signed.
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