The Purchase Contract Flashcards
Okay! That’s it for our review. Now let’s get into the purchase contract!
The Purchase Contract, Defined
A purchase contract is a contract used in the sale of real property that outlines the responsibilities of the parties and terms of the sale. It is the blueprint for the completion of a real estate transaction.
The purchase contract is often the most important document in a real estate transaction because it:
Establishes the details of the agreement between the buyer and seller
Identifies the legal rights and obligations of the buyer and seller
It can also be called a sales contract, purchase agreement, or purchase and sale agreement (PSA).
Types of Purchase Contracts
There’s a lot of variety when it comes to sales transactions. Some common real estate purchase contracts are:
Residential Contract of Sale
Commercial Contract of Sale
Foreclosure Contract of Sale
Contract of Sale for New Construction
Contract of Sale for Land
Exchange Agreement
The most common transaction you’ll probably deal with is a residential sale, so that’s the contract we’ll focus on most.
No Promulgated Purchase Contracts in Arizona
Arizona does not promulgate contracts. In other words, there is no standard purchase contract that must be used for all real estate transactions.
What’s a Purchase Contract?
As an agent, you will likely use whatever contract form is standard for your brokerage to use. This could be a contract prepared by the brokerage’s attorney. If the broker is a REALTOR®, you might use contracts from the Arizona Association of REALTORS® or a local REALTOR® association.
Article XXVI of the Arizona constitution states that a license holder may draft or fill out any instrument relating to real estate, including contract forms. Your role will most likely be filling in the blank spaces provided in the forms. Make sure to fill in every blank, using “N/A” for fields that are not applicable. Your broker will be responsible for any errors or incompleteness of contracts you fill out.
Also, note that you won’t be allowed to charge a fee for completing contracts, which could be considered practicing law. It’s best practice to avoid striking out sections, changing their meaning, or adding unusual information that the form is not designed for. Never discourage your client from consulting an attorney if they have questions or concerns.
Explain, Don’t Advise
As the license holder, you are free to explain to the principals the meaning of the factual statements or business details contained in the contracts as long as you do not offer or give legal advice. That would be the unauthorized practice of the law!
It’s one thing to simply read the form with the client to help them understand the meaning. That’s your goal. It’s another thing when the client does not understand or begins to ask the license holder what they should do. That’s when the real problems can occur.
Who Writes a Purchase Contract?
But what’s actually in that contract? You should understand the kind of language that commonly appears in a contract for sale. An agent will be responsible for helping their clients hit the deadlines and fulfill the obligations outlined in the contract.
For buyer clients, that might mean ensuring they obtain insurance and get funding in place to close on time.
For seller clients, that might mean reminding the seller of their obligations to do the repairs listed in the contract before closing.
Purchase Contract Requirements
A purchase contract must:
Include the names of the parties involved
Identify the subject property
Be signed by the parties bound by the contract
Contain evidence of intent to convey an ownership interest
Contain the terms of the sale
State the purchase price
Typically, purchase contracts will also include:
Mortgage details
The deposit amount
When and where the closing of the transaction will take place
Inclusions and exclusions (what is included in the sale of the property)
A section regarding inspection
Acceptance procedures and deadlines
Property disclosures
A close-up of two people pointing out lines on a contract.
Important Reminders
The purchase contract form you use may include a cover sheet as its first page. This cover sheet may include a checklist of important reminders for the buyer. It can also be a great resource for you when you serve as a buyer’s agent.
Buyers in a real estate transaction must be informed that they should:
Read the whole contract before signing it, as it is a legally binding document
Understand the contents of the Residential Seller’s Property Disclosure Statement
Arrange for any property inspections that are important to them
Make sure they will be able to get insurance for the home
Apply for a mortgage if using one
Review the title commitment, CC&R’s, and related documents within five days of receiving them
Do a final walkthrough of the property before closing
What’s in a Purchase Contract?
The Property
What does the purchase contract have to say about the property itself? Keep reading, Anthony!
Property Description
A purchase contract will include the street address and the legal property description.
As you may remember, a legal description is more detailed than a street address, as it is a description of a property that is distinct and precise enough to distinguish it from all other properties. Types of legal descriptions include metes and bounds, rectangular surveys, and the lot and block system.
A purchase contract must contain a legal property description that uniquely identifies the property involved in the transaction.
Personal Property
The contract should be explicit about any personal property that is to be conveyed with the sale of the real property. For example, the buyer might negotiate for the seller to include a rug in the sale. When the real property transfers to the buyer at closing, that personal property transfers with it.
The contract might also provide room to specify items that will NOT be conveyed in the transfer of the real estate. These would be items that normally convey with real estate, but that the seller wants to keep. For example, a light fixture, an appliance, a tree, or other such items might be listed as excluded items in the purchase contract.
Deed and Title
In the contract, the seller agrees to convey a marketable title that is free of encumbrances and liens to the purchaser via deed.
A deed is an official document that shows the owner has the legal title to the property.
A title is not something you can hold. It’s an abstract concept that includes someone’s ownership rights to a specific piece of real property.
The type of deed used in a transaction could vary depending on the transaction type and where the transaction occurs.
Close of Escrow
Close of escrow (or “COE” as the pros call it) occurs when the deed is recorded at the county recorder’s office. The COE date will be listed in the contract and serve as a deadline for the buyer and seller to perform all acts and supply all documentation necessary for the COE.
Possession occurs when the buyer gets the keys and is permitted to move into the property. This could occur on the same day as COE or a different date noted in the contract.
Risk of Loss
This clause in a purchase contract states what happens if there is any damage to the property before it is transferred to the purchaser. For example, what if a tornado hits the house? The contract will typically specify that the seller is responsible for any loss or damage to the property before the close of escrow (COE) or possession by the buyer.
Notes
Funds paid to confirm or commit to a contract are considered earnest money. Earnest money shows that the buyer is highly interested in the property and is willing to close the sale. It is essentially a deposit that a buyer makes to show that they are making the offer in good faith and are serious about their offer.
The contract will typically spell out:
What form the earnest money will take (i.e., cash, check, etc.)
When it must be paid
To whom it must be paid
Where the earnest money will be held
How to disburse the funds
How to refund the funds if the transaction fails
As the sales agent, you’ll need to forward the earnest money to the listing broker ASAP. From there, the broker deposits in their trust account at an escrow company. This should happen no later than the next banking day unless otherwise specified in the contract and agreed to by all parties. If the earnest money won’t be held in an escrow account, this must be disclosed in the contract. The buyer must initial and sign below the disclosure.
No Earnest Money? No Problem!
A buyer is not required to include earnest money with their offer at all. The offer (and contract, if accepted) would be valid. Still, the inclusion of earnest money is common enough to be expected and can help an offer’s chance of acceptance.
Earnest Money
A contract could include the phrase time is of the essence.
This phrase communicates to parties of a contract that they must perform their contractual duties by a specific date and time in order to avoid a breach of contract. (In the absence of this provision, “reasonable” delays may be considered acceptable.)
All time limits in the contract, then, will be strictly applied. For example, if the contract states that the option period ends at 5:00 p.m. five days after the contract is signed, this means 5:00 p.m. on that fifth day and not a minute after. The buyer can’t roll up at 7:00 p.m. and be all, “Sorry dudes, but I’ve decided I don’t wanna commit to the purchase. I’m just trying to find myself right now, you know?” Too late!
Failure to act within the specified time required would equal a breach of the contract.
Agent Pro Tip
Let’s talk a little more about the inspection period. When creating the offer, the inspection period is super important. Listing agents advocate for short periods of time, with some agents advocating five days or less. Buyer’s agents, on the other hand, should be advocating more days, say 10.
Here’s a potential problem that may surface during a short option period. The buyer needs to hire an inspector, and let’s say that the inspector they want to hire is busy for two of the five days in the agreed option period. On day three, there is an inspection and the written report is furnished on day four.
The report calls out some issues (such as electrical wiring) that will take days to investigate — more days than what was originally negotiated. The buyer then has two choices.
Cancel the transaction
Attempt to negotiate an extension of the inspection period
The seller might not want to extend the inspection period, or they might want a large sum of money to extend. The seller could even have a back-up contract in place.
As this example shows, because there wasn’t a reasonable or adequate amount of time to complete due diligence, the existing contract risks being terminated and at the very least creates an inconvenience for all parties.
So this is why it’s important when creating an offer, make sure there is a proper amount of time allotted for performance.
Time Is of the Essence
Let’s say that one or both of the parties defaults on the contract. They don’t perform their contractual obligations by the stated deadline. What happens then? Look for a “Remedies” clause that will spell out how conflicts will be handled.
Cure Period Notice
If a party is not properly fulfilling their obligations, the other party can give them a cure period notice (CPS). This notice says the offending party has three days to either get into compliance with the contract or be in breach of it.
If the CPN period ends and the party is still not compliant, they can lose their earnest money, be sued, or be subject to other penalties.
Mediation
Arizona sales agreements usually call for mediation as an alternative dispute resolution strategy. The provision will explain that mediation is not binding arbitration and that those involved will voluntarily settle with the help of a mediator.
Mediation clauses typically state that any dispute related to the contract will be submitted for mediation first. The clause will also state what kind of issues will not be resolved through mediation.
Default by Parties
Most real estate contracts will include at least one or two contingencies. A contingency is a provision within a contract that makes performance conditional upon the occurrence of a stated event.
Another way to put this is until the contingencies have been fulfilled, the contract is voidable or unenforceable.
Loan Contingency
A loan contingency makes the sale contingent on the buyer obtaining an adequate mortgage loan.
A unique feature of Arizona purchase contracts is the prevalence of automatic loan contingencies. Most homebuyers use a mortgage to make their purchase, so instead of making buyers attach or write in a loan contingency, it may be built right into the contract form.
Appraisal Contingency
An appraisal contingency enables the buyer to get out of the purchase contract if the appraisal comes in lower than a certain amount. (An appraisal is an estimation of property’s value as of a specific date, performed by a certified appraiser.)
Buyers don’t want to get stuck having to buy a property that isn’t worth as much as they’d thought.
Arizona purchase contracts will typically include an appraisal contingency automatically. It may state that, if the property fails to appraise for at least the purchase price, the buyer has five days to either cancel the contract (and get earnest money refunded) or waive the contingency.
Contingent on the Sale of Another Property
Transactions that are contingent on the sale of another property happen quite frequently in real estate. In these situations, the buyer needs to sell their current home in order to afford the new home. The sale of another property contingency is meant to protect buyers from owning two homes at once and ensure the buyer has enough funds for closing.
Inspection Contingency
The sale is contingent on the property passing inspections. So, if the inspector finds that the roof is leaking all over the place, or something else equally problematic, the buyer can back out of that rotten deal. Never advise your client to waive their inspection period!
Attorney Review Contingency
There might be a clause in the contract that makes the contract contingent on the approval of the parties’ attorneys. This clause will give the attorneys a certain amount of time to look over the contract and grant their approval or disapproval.
Contingencies: Definition and Types
Termination Under Contingencies
A contingency should state within itself how and when termination is communicated. Communicating a termination is like communicating an offer in terms of importance and priority.
Prevent Contingency Abuse
Both sellers and buyers can abuse contingencies as a way to cancel the contract without defaulting. We don’t want that! In order to avoid this, the contingency should:
Be very clear
Contain an expiration date
Explicitly require diligence and effort to fulfill the obligation (if the contingency isn’t specific about who does what when, parties can take advantage.)
Review of Contingencies
Need a lil’ review? Here you go!
A chart reviewing contingencies: mortgage, appraisal, sale of another property, inspection, attorney review.
Image description
Now, let’s play Facts of a Feather to make sure you’ve got the various contingencies straight.
Contingencies: Termination and Abuse
The contract will typically have a paragraph where you indicate any relevant addenda and mandated forms that will be attached.
Remember, an addendum (the singular version of “addenda”) is an addition to a completed contract that specifies supplementary information to the contract that was not previously included in the contract. An attorney should review all attached addenda to make sure they don’t create any unwanted changes in the contract.
If there’s a conflict with anything in the contract, the addendum controls.
If you belong to a REALTORS® association, you will find many of these addenda as forms you can fill out. If there AREN’T forms, get a lawyer to write these addenda.
Examples of Addenda
Lead-Based Paint Disclosure
Loan Assumption Addendum
Buyer Contingency Addendum
Copy of the Public Report, if the property is in a subdivision
Addenda
So, the contract is drafted, addenda and special stipulations have been included, and the ink is dry on the last signature. What else remains?
Well, what if, after all that, a party wants to change something? Enter amendments!
Remember, addenda are attached to the original document BEFORE it is signed. An amendment, on the other hand, is for the use of the buyers and sellers AFTER they have fully signed and accepted a contract and then later discover a change that needs to be made to one of the terms.
Inspection Period
Modifications by way of amendment to a contract can occur at any time between the contract date and closing. However, most amendments will occur during the inspection period — a time during which buyers have the most leverage to make the contract “right.”
Neither party is required to agree to an amendment to the original contract, but failure to do so may cause the contract to terminate.
Additionally, there is no limit as to the number of amendments a contract can have. One or two is typical, but there is no hard and fast rule about this as long as all parties agree to the changes.
Common Amendments:
Change the price, down payment, or loan amount
Request that the seller perform repairs and/or treatments listed in an addendum
Change the closing date
List an amount of money the seller will pay of the buyer’s closing costs
Extend or terminate the inspection period
Amendments
The signing of the contract is one finish line, but the closing is another. What do you do in that stretch of time between signing and closing?
Keep an open line of communication. Talk to all the parties!
Make sure that all relevant parties have a copy of the signed contract. That includes the buyer, the seller, the brokers, the lender, and the closing attorney.
Remind your client that “time is of the essence” means exactly that. If you represent the buyer, and they do an inspection, find termites, and then decide to terminate but wait until AFTER the due diligence period is over, well, they are out of luck.
Follow up on loan applications. Don’t let these slip through the cracks!
Prep parties on what will happen at closing. If they want to read all the relevant documents, they can, but have them do it before closing. They won’t have time at the closing itself.
Give parties cost and net worksheets ahead of closing. These will approximate closing costs.
Go to the closing. You aren’t required to do this, but it’s nice.
Contract to Closing
Now that you know all about the typical residential purchase contract, let’s preview a few additional types of purchase contracts.
Remember co-ops from earlier in the course? Cooperative apartments (co-ops) are owned by a corporation, so buyers don’t receive a deed when they purchase a cooperative apartment.
Instead, the buyer is technically buying shares of the cooperative. These shares are considered personal property, not real property. And through buying the shares, the buyer is given a proprietary lease to the apartment. Because the buyer of a cooperative apartment isn’t buying real property, they won’t use a mortgage for financing.
Uniform Commercial Code
Instead, the buyer takes out a loan regulated by the Uniform Commercial Code, which is a uniform act (a state law enacted by all 50 states) that regulates the sale or transfer of personal property.
Flip Tax
The purchase contract for a cooperative apartment will include much of the same information as a regular real estate purchase contract. There might be some additional charges outlined in the contract, including a flip tax. The flip tax is a fee paid by a seller during a housing co-op transaction.
Board Approval
One of the most important differences is that purchasing cooperative shares requires the approval of the corporation. So the purchase contract includes a section detailing what the buyer must do if they hope to gain the corporation’s approval (usually called “board approval”). Often this includes personal interviews and references. 🤝
Co-op Purchase Contract
There are special contracts used for the purchase of condominiums, as well. Since there are common areas and other specific features to account for, a condominium purchase contract will include provisions that address this. A condominium contract needs to be specific about what the buyer will own, won’t own, and will co-own with their neighbors in the complex.
Right of First Refusal
Another subject you may see on a condo contract is the “right of first refusal.” With condominium sales, the condominium association has this right. This means that if the owner of a condo decides to sell their unit, the association has the first chance to buy or lease it. The condo association might want to buy the property for various reasons, whether it’s to convert it to the superintendent’s apartment or to make it an office for the association.
The right of first refusal doesn’t specify a sales price. It just says that the right holder can match any acceptable offer that comes in during a negotiated period of time. That time period and any fee charged for the right of first refusal are negotiable. If a seller’s property is subject to a right of first refusal, they have to notify interested buyers of this fact.
Condominium Purchase Contract
Speaking of condos, I want to mention the letter of intent. We talked about these before, but let’s reframe them in the context of condos.
The sponsor of a condo project may ask a prospective buyer to sign one. The letter of intent signifies an agreement to do business together, but is not binding. Often, a buyer signs the letter when they want to reserve a specific unit.
Benefits for Both Seller and Developer
A letter of intent shows the seller that the buyer is willing to enter a transaction. Meanwhile, a developer can show letters of intent to their lender to persuade the lender to fund the development. Lots of letters of intent show the lender that the development is not a financial risk.
Right of First Refusal
After submitting the letter of intent, the potential buyer will put down an initial deposit and have the right of first refusal. In this context, it’s the buyer who gets first dibs on buying the unit before it can be offered to anyone else. From there, the buyer has two options:
Terminate the agreement and get their deposit returned
Move forward with the sale and sign a binding contract
The actual contract will be more detailed than the letter of intent.
Letter of Intent
