Contracts Study Guide for the Real Estate License Exam

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Contracts of Sale

In this section, we will cover the mandatory parts that a sales contract needs to contain to make the contract valid and enforceable. We will also define the parties responsible, when applicable.

Contract Validity

In order to be valid, a contract must:

  • Be entered into by legally competent parties
  • Be in writing
  • Contain a legal description of the property
  • Have words of mutual agreement to buy and sell
  • Have consideration
  • Be signed by all parties
  • Have a legal objective

Party Interest and Identity

The buyer and seller must be identified by name or, in the case of a company, by the company name. If a contract is to be assigned to another party before the sale closes, there should be a phrase similar to: Buyer John Smith, and/or Assignee.

Description

The contract must contain a legal description of the real estate being sold that is sufficient to locate the real estate. A street address is not a legal description, even though a house can be located with an address.

Price and Payment Information

The contract must contain the total price being paid for the property, the amount of earnest money, and the final amount due on the settlement date. The contract should also describe how the final amount due is being paid—such as “in cash” or “new first loan”.

Terms of Sale and Contingencies

Sales contracts contain contingencies or conditions that one party or the other needs to meet in order for the sale to close. Common contracts contingencies include: buyer approval of property inspections, buyer obtaining financing, and seller providing a clear title.

Date of Settlement

The date of settlement is when the contract is terminated by performance, title transfers from seller to buyer, and money changes hands. Sometimes, the date of settlement can be a mutually agreed to number of days after all contract contingencies have been removed. Usually, when selling a house, the date of settlement is a specific date during the business week mutually agreed to when the contract was signed by all parties.

Party Signatures

Both buyer and seller must sign the contract of sale for it to be valid. If one of the parties is a company, then a real person authorized to sign contracts on behalf of the company must sign.

Negotiation

Negotiation is what takes place before there is a “meeting of the minds” and a contract is signed. Negotiation is not just about price. The process of negotiation can include items such as the amount of consideration or earnest money, the type of loan a buyer will qualify for, credits that the seller will give the buyer, and the specific settlement date.

Offer

After consulting with the buyer, the buyer’s real estate agent will complete the contract for sale, have the buyer sign the contract, and present the offer to the seller’s agent, along with any supporting documentation—such as loan approval, or proof of funds for a cash sale.

Counteroffer

The original offer from the buyer can be accepted as-is by the seller, rejected outright, or the seller can make a counteroffer. When a seller agrees to a buyer’s offer, except for certain terms or conditions, the seller will make a counteroffer to the buyer. Sometimes, a contract can have multiple counter-offers before the buyer and seller agree to everything.

Acceptance

When negotiation is done and the buyer and seller agree to all of the terms and conditions, all parties will sign the contract. This is called contract acceptance. Although the parties can verbally agree, the contract is not a done deal, valid and enforceable, until the parties sign on the dotted line.

Contract Parts

All legally binding contracts must have a legal purpose, be mutually accepted, have consideration, and be voluntarily accepted by competent parties. Real estate contracts also contain very specific information on the property transaction, and we will discuss those now.

Assignment—When one party gives or hands off the benefits and obligations of an existing contract to another party, they have assigned the contract. The giver of the contract is the assignor, and the person getting the contract assigned to them is the assignee.

Financing—Real estate contracts contain something called a financing contingency if the purchase is not for cash. Financing conditions can be general, or they can contain very specific financing conditions such as an Federal Housing Administration (FHA) loan, maximum interest rate paid, or a seller down payment credit to the buyer.

Earnest money—Sometimes called a good faith deposit, earnest money in a real estate contract shows the buyer is serious about buying the property. If the buyer finds something wrong with the property or is unable to qualify for financing, the earnest money is normally returned to the buyer.

Deed type—Deeds are legal documents that transfer the title to real estate from the seller or grantor to the buyer or grantee. The real estate contract will state if the deed type is general warranty, special warranty, bargain and sale, or a quitclaim deed.

Evidence of title—This means that the seller has satisfactorily shown that he or she owns the real property that is being sold. Abstract and opinion, certificate of title, title insurance, and Torrens certificate are the four kinds of evidence of title.

Approval of title—After the seller provides its evidence of title, the title needs to be approved. Sometimes, this is also called clearing the title. This step is done by a title company, escrow company, or sometimes a real estate attorney. A clear title means there are no liens or encumbrances on the property, and that there are no missing links in the chain of ownership.

Property condition—After the purchase contract is signed by the buyer and seller, the seller will give the buyer a disclosure that lists any property issues the seller knows about. Buyers will also do their own property inspections. Property inspections can include the roof, foundation, electrical, plumbing, mold, radon, and pests such as termites, scorpions, or rodents.

Prorations—Sometimes, a seller has prepaid for things that are not due until after the title is transferred to the buyer, such as property taxes or an HOA assessment. Prorated real estate expenses appear on the closing statement as a credit to the seller and a debit to the buyer.

Loss—Sometimes, there is damage to a property between the time the purchase contract is signed and the sale closes. Because the seller still owns the property during this period, the seller is obligated to repair what has been damaged or destroyed, so that the property is in the same condition as when the buyer signed the purchase contract.

Possession date—This is when the buyer gets the keys and takes possession of the property. Usually, possession occurs on the closing date. Sometimes, the seller will give the buyer an early possession to move in, or the buyer will delay its possession so that the seller can move out after closing. Real estate agents should be aware that either of these can be risky and advise their clients accordingly.

Closing date—This is the day when money changes hands, the buyer gets the keys, and the title is transferred to the new owner. It is also the date when real estate agents earn their sales commission. Usually, the closing date is the same date as the possession date.

Broker—A real estate broker is the individual who is responsible for supervising a real estate agent and the transactions the agent is involved with. The buck always stops with the broker, so to speak. Larger real estate companies, sometimes called brokerages, may have associate brokers who help in supervising real estate agents.

Default—If the buyer, the seller, or both fail to perform one or more of the terms in the contract that they have agreed to, they have defaulted on the contract. Defaults can also result in damages having to be paid. If a buyer defaults, usually the seller keeps the earnest money. If a seller defaults, usually the buyer can take the seller to court.

Contingencies—These can also be thought of as Ifs in a contract, where if one party approves or gets something, then the contract will continue. Common contingencies in a real estate contract include inspection contingencies, and financing or mortgage contingencies.

Other provisions—Also known as stipulations, provisions in a real estate contract are sometimes things that have to be done by a specific date or within a certain amount of time. Provisions will also protect the interests of the buyer, the seller, or both parties.

Signatures—In order to be legally binding, a real estate contract, and any other documents that are part of the contract, need to be signed by all parties. The buyer and seller do not need to sign at the same time. Some states also allow the use of electronic signatures.

Power of Attorney

Also known as a POA or letter of attorney, power of attorney is a written authorization for one party to act on behalf of another party. The person giving the POA is the principal or grantor, and the person being authorized is the grantee. The person being given power of attorney does not have to be an attorney.

Deeds

Deeds are written legal documents used to transfer or convey property title from an owner or grantor to another party known as the grantee, usually the buyer. Deeds can contain limitations on property use and promises, also known as covenants.

Types of Deeds

All deeds are not created equal. Deeds can vary in the covenants and warranties—or guarantees—that are conveyed from grantor to grantee. Some deeds have a large number of warranties and covenants, while other types of deeds have little or none. Deeds can also be used to remove encumbrances from a property, and to help create a clear title.

General Warranty

A real estate buyer receives the best protection with a general warranty deed. This type of deed guarantees that the property is free of any liens, encumbrances, and claims going back to when the property was originally created.

Special or Limited Warranty

This type of deed is used when a grantor or seller only warranties the real property against any defects in clear title—liens, encumbrances, and claims—to the grantee or buyer for the period that the grantor owned the property. It does not protect the buyer against any potential claims from the time prior to the grantor owning the property.

Quitclaim

A quitclaim deed—also known as a quit claim deed—provides no warranties or assurances from the grantor or seller to the grantee or buyer. As the name suggests, the grantor simply quits his or her claim to the real property and turns it over to the grantee. Often, quitclaim deeds are used by outside parties who may hold claims, in order to get the title fully clear.

Requirements of a Deed

To be both valid and enforceable, a deed must meet six requirements:

  1. The front of the document must contain the word Deed.
  2. The deed must state that it conveys a thing or privilege.
  3. The grantor must be able to legally give, and the grantee must be legally able to receive.
  4. The grantor must execute the deed in the presence of witnesses.
  5. It must be delivered and accepted between parties.
  6. In some states, the deed must be sealed or stamped.

Deed Parts

There are three main parts—or clauses—of a deed. The premises part includes the parties, recitals, and testatum clauses. The operative part includes the operative, parcels, habendum, tenendum, reddendum, conditions, warranties, and covenants clauses. The conclusion part contains the testimonium clause and attests to the execution and date of the deed.

Execution of a Deed

An executed deed is when the deal is done and the title is transferred. Execution of a deed means:

  1. The grantor has signed the deed.
  2. A witness acknowledges that the grantor is signing the deed voluntarily and is not impaired.
  3. The deed is delivered to, and accepted by, the grantee. This last part is also called conveyance of title.

Alienation

Alienation means that real property has transferred from one party to another party. Another way of thinking about this is that a real estate seller is alienated, or separated, from the property when it is transferred or deeded to another party such as the buyer.

Contract for Deed

A contract for deed is also known as an installment sale agreement. Under a contract for deed, the buyer makes periodic installment payments to the seller. The seller keeps legal title to the property until the final payment is made. The buyer does not receive legal title to the property until all of the payments have been made to the seller.

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