How Purchase Contracts Work

Every purchase and sale of real estate requires a written contract. Tenant agreements may be legal with a handshake, but not purchase agreements. The US Statute of Frauds requires a written contract every time real estate changes hands.

Most state Boards of REALTORs promulgate a standardized purchase agreement contract, available to the public and used for most transactions of one-to-four unit residential buildings or raw land in that state. You don’t have to use their contract, but they usually include everything you need to make a legal transfer, including particularities for that state. Alternatively and even better, you can hire a lawyer to draft something up for you and supervise all advancements during a purchase.

Commercial transactions usually require more complicated contracts, often reviewed and even drafted from scratch by attorneys on both sides. The transaction often starts with the parties agreeing to basic terms of the sale with an informal and non-binding contract called the “letter of intent” (LOI). Executing an LOI means that the seller stops looking for another buyer and the attorneys go to work hashing out a binding contract called a “purchase and sale agreement” (PSA).

While purchase contracts vary by state and vary in complexity, some terms and clauses are universal. Almost all purchase contracts include the following:

Definition or Description of the Property to Be Sold

This may include the street address, the legal description of the property, or both. A legal description is a more official description of the property as recorded by the county tax collector or registrar by the lot and block, metes and bounds, or township methods.

Definition of the Parties

The individual or entity buying the property is named, as is the individual or entity selling the property. Throughout the rest of the contract, they will be referred to simply as Buyer and Seller.

Purchase Price

The purchase price agreed upon by both parties.

Earnest Money Deposit

An “earnest money deposit” is a deposit the buyer submits to make his/her claim on the property official. It can be of any amount agreed upon by the parties, although 1-3% of the purchase price is common, with more earnest money often making an offer more compelling.

Earnest money counts towards the purchase price is refundable during the contingency period (see below) but not refundable after the contingency period. If contingencies expire or are waived and the buyer decides to back out of the deal, in theory the seller gets to keep the earnest money and then look for a new buyer.

Option Period

An “option period” is an agreed-upon period wherein the buyer has the “option” to buy the property … this means the seller can’t offer it for sale to another buyer. This might be extra time before earnest money is due—say, a week or maybe even a month—time the buyer could use to determine if the property makes financial sense or if (s)he can obtain financing.

Option periods usually entail an “option fee”—anywhere from $10 to $1,000 or more. This money may or may not count towards the purchase price and is not refundable under any circumstances, even if the buyer backs out before contingencies expire.

Prospective Closing Date

A date is identified by which the deal might close. Conditions might be included under which the date might be extended.

Escrow and Title

An escrow agent and title insurance company will be specified.


“Contingencies” are usually periods of time that allow the buyer to perform due diligence. They usually come with an attached period of time—14 days, 30 days, 60 days or even more—and fall into one of two categories:

  • Inspection Contingency – The buyer has the right during this period to have the property inspected by inspectors or contractors of their choice, as well as inspect documents like utility bills, occupancy certificates, etc. The buyer’s lawyer also has the opportunity to inspect the seller’s title to make sure that there are no obstacles to the sale. If the buyer discovers defects in the property before the inspection contingency expires, he/she may back out of the deal and get the earnest money refunded.
  • Financial Contingency – A financial contingency allows the buyer to make a good-faith effort to obtain financing—usually a mortgage loan, bridge loan, or construction loan, whatever is appropriate to the deal. Most financial contingencies include a professional appraisal, as the appraised value of the property determines how much a financial institution will be willing to lend on a property. If the buyer fails to obtain financing during the contingency period, he/she can back out of the deal and get the earnest money back.

There are many contracts you must be familiar if you are planning to manage property. Here you can read about trust deed loan contracts and here you can read up on tenant agreements.



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