What Makes a Contract of Sale Valid? Study Guide for the Real Estate License Exam

General Information

In real estate, when a seller and buyer exchange property, a legal contract of sale is needed. While it is technically possible to simply exchange a property deed for payment, this would put the buyer at risk. Contracts of sale help ensure each party knows what is expected of them, and they are also required to be considered for any type of mortgage lending.

Depending where you live, a contract of sale may also be called an agreement of sale or earnest money contract. Whatever the name, the purpose is the same: to legally define the terms of sale of a piece of real estate. The process of creating and executing a contract of sale must always include the following.

Negotiation and Offer

A contract of sale begins when an offer is made on a piece of property. The potential buyer usually knows what the property is worth and what the seller is asking. They may offer the seller’s asking price, lower than the asking price, or sometimes, in a competitive market, greater than the asking price. Once an offer is made, the seller can accept it, turn it down, or make a counteroffer. Negotiation continues until both parties come to a satisfactory (or unsatisfactory) conclusion. In the negotiation part of a real estate transaction, there is no contract of sale. Either party is free to walk away until an offer has been made and accepted. Once an offer has been accepted, the contract of sale is in effect.

Identify the parties

In a contract of sale, the seller and the buyer must clearly be identified using their full legal names. The title should contain only the name of the seller, as no one else should have claim to the property being sold. As in all contracts, both the buying and selling parties must be legally competent to enter into the contract.

Real Estate Description

The most important part of the real estate description is accuracy. Metes and bounds, lot numbers, monuments and occupancy, and, in some areas, rectangular surveys are all used to describe the property precisely. In very complicated property types, it is acceptable to refer to a reference outside of the contract of sale that describes the property in detail, such as the existing recorded property deed. Description by reference, as it’s called, is only acceptable if anyone reading the contract could easily access the reference, and the description in the reference is exactly the same as what is being offered in the current sale.

Price, Payment, and Contingencies

The contract of sale must clearly state the price of the property and how the buyer has arranged to pay for it. Often, a buyer does not have enough money to make an entirely cash sale, so the contract should include the amount of cash payment being put down, as well as the amount of mortgaged (borrowed) money being offered. If a buyer does need to secure a mortgage to complete the sale, it is a good idea for them to include mortgage contingencies as part of their agreement. A contingency is an unforeseen occurrence that may take place that allows for the cancellation of the sale without penalty. For example, if the buyer can only afford a mortgage with a 3.5% loan but the bank is only willing to give them a loan with 5% interest, they should include having a loan with a 3.5% interest rate or less as a contingency of their offer. Other examples of contingencies include things like the home being found structurally sound upon official inspection or agreement to purchase after the buyer’s current home has sold.

Closing Date and Signatures

The closing date, or settlement date, is the date by which all parties should have met their required duties as stated in the contract of sale. It is significant because it is the day when the deed of the seller is officially exchanged for payment from the buyer. The closing date may be amended, but doing so must be agreed upon by both parties. At closing, both parties must sign the deed of sale. It does not need to be notarized.