For homebuyers, real estate contracts can be bittersweet. The prospect of buying a house is exciting, but the process can be daunting. There’s a lot at stake — your new home! — and a lot of boxes to tick before closing the deal.
Preparing for and wrapping your head around all the requirements leading up to the biggest purchase of your life is no small feat. It all hinges on what’s in a real estate contract. Knowing the composition of a real estate contact that’s competitive, realistic, and protects your best interests can literally make or break the deal.
As you begin the search for a home to call your own in the next town or neighborhood to settle into, deftly navigating a real estate contract will help you conquer any obstacles along the way. Armed with the knowledge you need will lead you to a quick and painless closing in no time, and we’ve done the research for you. We talked with industry experts with decades of experience to help you tackle your real estate contract, each step of the way.
How a real estate contract works: The basics
When you’re buying a house, a real estate contract is the legal document that outlines the terms and details of a real estate transaction. The most common type is a purchase agreement (more on that later).
The primary purpose of a real estate contract is to clearly identify expectations of the buyer and seller and protect them both in the purchase process. Let’s break down how the contract works.
An official offer form is prepared by the buyer’s real estate agent and submitted to the seller to accept or counter. Among other details, the offer will include a description of the parties and property, the purchase price offer, the earnest money deposit amount, the closing costs involved, and the proposed closing date.
The seller accepts or rejects the offer. If the seller counters the offer, the seller or their listing agent will send back a counter-offer for the buyer to likewise accept or reject. A counter could include changes or modifications to one or more components of the offer, like purchase price, closing costs, or a contingency.
It’s a deal! Or not. Once the seller accepts the initial offer or the buyer accepts the counter-offer, it becomes a legally binding contract, and both the buyer and the seller work to meet the terms and conditions outlined in the contract. If the buyer and the seller can’t agree on all the terms laid out in the offer, there is no agreement or contract.
So how quickly do negotiations and the offer become a signed, legally binding contract? Pretty quickly, says Peter Chicouris, a top-selling agent in St. Petersburg, Florida who’s sold 75% more properties in St. Petersburg than the average agent.
If there is only one buyer submitting an offer on a property, “most of the time a transaction is agreed upon in the first 24 hours,” says Chicouris.
In a multiple-offer situation, “many times a seller will put the property on the market for 24 to 72 hours, knowing that they have an aggressively priced property.” After the time allowed for multiple offers to come in, the seller will make a decision based on the best price and closing date.
“Once the offers are in for review, usually within 24 hours there’s a commitment and a signed contract,” Chicouris adds.
Decoding a real estate contract
Unless you have experience in the real estate industry or with buying property, you probably have no idea what a lot of the terms in a real estate contract mean. Let’s start with the most important things to know and then dig into the extras.
As in many of life’s cases, “price is the first thing,” says Chicouris. When it comes down to it, the best or highest price usually wins, especially when there are multiple offers.
Asking your real estate agent for a comparative market analysis is to your benefit. This way you can assess whether the seller is pricing at, above, or below market value and strategize how much to offer accordingly.
The second-most-important consideration of a real estate contract is the timeline for obtaining the title, financing, and inspections.
Usually the next step following the signed offer is the home inspection, notes Chicouris. Once the inspection has been performed and passed, “that’s one less contingency for the contract, and it strengthens the contract. Everyone is proceeding to closing.”
There are other pieces of the real estate contract puzzle, including:
A rider, otherwise known as an addendum, is an add-on to a real estate contract that modifies it based on the unique circumstances of each buyer and seller relationship. They are put in place to safeguard the specific needs of each party involved in the transaction. According to Chicouris, some of the most popular riders he’s seen attached to real estate contracts include:
- Disclosing the rules and regulations of a homeowners association, if applicable to the property
- A Federal Housing Administration rider, especially common with first-time homebuyers, specifying the buyer will be securing a mortgage through the FHA. An FHA loan provides extra financial protection for the lender in case the buyer defaults on the loan and the home forecloses.
Contingencies are a list of requirements or conditions that must be met before closing. Essentially, the contract is contingent on these items, and without them the buyer can back out of the contract with no penalty.
Some common contingencies include the buyer obtaining a loan to finance the purchase, the buyer selling their current house, repairing or renegotiating the contract around any major issues or repairs found during the home inspection, and the house appraising equal to or higher than the sale price.
The inspection period can uncover some pretty significant issues that may require negotiating the purchase price, which is what the inspection contingency is there for. “The as-is clause pertaining to the property inspection happens to be the biggest issue that we’ve come across,” says Chicouris.
Sometimes, an offer will stipulate that the buyer will purchase the property as-is because it’s more desirable to a seller; however, if an inspection discovers a major issue involving the roof, A/C system, plumbing, or even a structural problem, the doors of negotiation are re-opened.
If the buyer still wants to purchase the property, the price will most likely be negotiated so the buyer won’t be held to the full market price on a home that needs substantial repairs. Likewise, the seller will realize the inspection results would need to be disclosed to the next buyer regardless.
This is when the agent’s experience comes in. “When you have a couple of agents that understand the circumstances and can explain it to both parties, it can be resolved and worked out. Then, the transaction moves forward,” said Chicouris.
Earnest money is a payment made by the buyer as a show of good faith at the signing of the contract. It’s part of the buyer’s down payment that they pay when the house goes under contract instead of at closing, and the amount can be negotiated between the buyer and seller.
“Typically, on a cash transaction the earnest money is preferred to be 10% of the purchase price. On a property that is being financed, I’m seeing anywhere between $2,000 and $10,000 depending on the value of the property,” says Chicouris.
Considerations are a key element of a real estate contract and simply mean anything of value that is exchanged as part of the transaction or agreement, which most often means money. However, there are times when alternative forms of considerations are offered, like a significant material item.
Buyers can use considerations to include certain pieces of furniture in the deal that the seller would ordinarily take with them, for example. And in one case, Chicouris had a buyer offer up a boat in lieu of money.
Closing costs are any additional fees beyond the purchase price necessary to transfer the home to the buyer, such as title insurance, notary fees, and transfer tax, to name a few. Whether the buyer or the seller is responsible for paying closing costs varies from state to state and deal to deal.
A real estate agent can best advise on the closing cost standards of the market and whether they can be negotiated between the buyer and the seller. Generally, closing costs average from 2% and 5% of the purchase price.
Once all the above terms are agreed to and each party signs the contract, it is legally binding. At that point, if the buyer pulls out of the contract without justification, their earnest money deposit can be forfeited, and in some cases the seller or buyer could sue each other.
Types of real estate contracts
Within the realm of real estate contracts, there are three main types used depending on the specific arrangement.
A purchase agreement is the most common type of real estate contract, used when a buyer is purchasing a home from the seller. The purchase agreement includes all the contract components outlined above and can fall in one of three main categories:
- State/association purchase agreement: This is most likely what a real estate agent will use when drafting a purchase agreement contract based on local Realtor association guidelines.
- General purchase agreement: This is a simplified, condensed version of the state/association agreement, usually selected when a buyer deals directly with a seller instead of working with a real estate agent.
- Property-specific purchase agreement: This type of contract is used for non-traditional properties, such as mobile homes and vacant land.
Real estate assignment contract
This is a type of contract an investor would use to buy the rights to a property, with the intention to assign the contract to a different buyer offering a higher price. There is a large market for wholesaling properties, which is when buyers and sellers use a real estate assignment contract. Usually a fixer-upper is sold as-is in a wholesale situation, so the investor makes a profit without having to put any work into the home.
A lease agreement is an agreement between the owner of a property and a tenant or renter. The lease agreement includes important details not found in a purchase agreement, such as how much rent costs and how often it is due, who is responsible for paying utilities, the security deposit requirements, penalties for late rent payments, and who is responsible for repairs to the property.
Regarding repairs, a lease agreement will typically state that the tenant is responsible for reporting them in a timely manner, and the landlord is likewise responsible for fixing them quickly. It will also restrict the tenant from making any major alterations to the property themselves, including painting walls or installing appliances without the landlord’s permission.
Now that you know the ins and outs of a real estate contract, you can proceed with the confidence that your offer will be strong and you’ll have all your bases covered for a seamless transaction.
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