You’ve found your dream home, the lake house you’ve been saving for, or the undisturbed backwoods property that would be ideal for hunting and fishing. Now what? By the time you’re ready to execute a Purchase and Sale Agreement with the property owner, you’ve likely overcome the most burdensome challenges that accompany property ownership: setting a budget, saving the money required to purchase the property, securing financing, etc. While a Purchase and Sale Agreement (“PSA”) doesn’t “seal the deal” and completely conclude the lengthy and sometimes tumultuous path to property ownership, it does represent the “beginning of the end” of a seller’s journey to property ownership. While a PSA does not exclusively apply to the sale and purchase of real property and can be used in other transactions, we will only be discussing PSA’s when it comes to real property in this article.
This article will explain what a PSA is, the terms and you can expect to see in a PSA, how a PSA contrasts with a Purchase Agreement (“PA”), and what you can expect once the PSA has been executed. We’ll begin with explaining, generally, what a PSA is.
Purchase Sale Agreement Explained
At its core, the PSA is a legally binding agreement that explains and sets out the terms and conditions for selling and purchasing the property, and what must happen prior to the sale and purchase occurring. The PSA will state the property’s purchase price, as negotiated by the seller and buyer. However, do not be deceived: the PSA is not a contract to purchase property. Rather, the PSA is intended as built-in protection that allocates responsibility amongst the parties and provides guidance on how the sale and purchase should be handled.
By executing a PSA, the parties prove their commitment to one another to be bound by the transaction. While it is not a “contract” to purchase the actual property per se, it is nonetheless a contract that sets the pending transaction into motion. A party who does not act in compliance with the PSA’s terms—thereby “breaching” the contract—can incur penalties accordingly.
Required Terms in a PSA
While the PSA is a contract, the PSA is unique in that many terms contained within are subject to change. As stated above, it should really be viewed more as a commitment to sell and purchase the home rather than a complete and total agreement as to all the details that conclude the sale and purchase. In this way, you can consider the PSA a living document. Naturally, you will want to include the legal names of both the buyer and the seller, and, like most legal documents, you can expect to see the definitions of terms used in the PSA.
- The Purchase Price
While a PSA is a binding, contractual agreement, it doesn’t necessarily bind the seller and the buyer to the purchase price. A PSA can be executed prior to any inspections or appraisals done on the property. Provided that there are no issues, the purchase price will stay as-is. However, if there are issues with the property, i.e., a leak in the ceiling, a broken sewer system, or some other problem that is material to the sale and purchase and will require money to repair, the purchase price can be renegotiated accordingly.
- Earnest Money
Agreeing to property doesn’t only involve a commitment to paying the purchase price. You’ll also need to put down an “Earnest Money Deposit,” or an EMD. An EMD is what the buyer is willing to put down to secure their chance at being able to purchase the property. In a competitive housing market, the bigger the EMD, the better. Like the PSA is a whole, an EMD shows the buyer’s commitment to purchasing the property. The EMD can be negotiated by the seller and purchaser, and once accepted by the seller, the EMD is usually held by the seller’s real estate broker or title company until closing and is credited towards the total purchase price.
- Closing Date
Usually, the PSA will include a closing date, or the date that legal ownership is handed over by the seller to the buyer. However, like the purchase price and other conditions in the PSA, the closing date can be subject to change, particularly when issues arise, such as an inspection that ends in necessary repairs being made.
Another way that PSAs aren’t set in stone is in the “contingencies” contained within them. Contingencies are a way to protect the buyer by providing them a way to avoid purchasing the property if certain conditions are meant. While there are many contingencies that can be held in a PSA, the more common ones are an inspection contingency, an appraisal contingency, a financing contingency, a home-sale contingency, and a title search contingency. Most contingencies are optional, with the financing contingency as an exception.
- Inspection Contingency
As discussed above, closing on the property at the agreed-upon sale price is subject to change; the inspection contingency represents possible change. An inspection contingency is done to make sure that the property is in the condition that the seller has reported it to be. Sometimes, needed inspections aren’t always visible to the naked eye or to the average property buyer. If an inspection reveals that the property is not truly in the condition it is reported to be in, the buyer has a way to avoid going through with the purchase or can attempt to renegotiate the purchase price accordingly.
- Appraisal Contingency
Like the inspection contingency, the appraisal contingency relates to actual value rather than condition. The appraisal contingency ensures that the property is worth the asking price. Keep in mind that in a competitive housing market, many buyers are willing to purchase a property at a higher price—that aspect isn’t relevant here. The appraisal clause is simply meant to ensure that the asking price is close to the actual value. Provided that the asking price is spot on with the appraised value, you’re likely out of luck if you decided to pay a higher price to beat out other potential buyers. Your EDM and the selling price represent the good-faith commitment you made to purchasing the property at the agreed-upon price.
The appraisal contingency is also important when it comes to the mortgagee (the person or entity, but usually the bank, that is lending you the money to purchase the property). An appraisal is necessary because the mortgagor wants a guarantee that they can be repaid the total loan amount if you default on your mortgage and the mortgagee needs to repossess and sell the property. An appraisal will be conducted by a neutral third-party and will usually take place within a 14-day period once the sales contract is executed by the seller and buyer.
- Financing Contingency
If the buyer is like most property purchases across the U.S., and probably the world, they likely don’t have the extra cash to pay for the property outright and will need to seek financing to purchase the property. A financing contingency (also known as a “mortgage contingency”) protects the buyer from purchasing the property in the event that a lender won’t agree to finance the loan amount. This contingency makes good sense when it comes to both the buyer and the seller. The buyer cannot buy a house they do not have the money to purchase, and the seller doesn’t want to be stuck in a transaction with a buyer who has no money. Although the timeline to receive approval on a mortgage can vary, usually, a buyer can expect a mortgage approval within three weeks. In addition, it is important to note that, unlike the other contingencies, this one is usually required.
- Home-Sale Contingency
It is not uncommon—especially when purchasing a home—that the buyer needs to sell their old home to be able to purchase a new one. Here, the home-sale contingency will allow the buyer to avoid purchasing a new one if their old one can’t be sold. Or, because a PSA can’t last indefinitely, the PSA could become void (as a matter of law) if the buyer cannot sell their home within 30-90 days, unless they have the excess cash or can come up with the financing to purchase a new home without selling the old one. This contingency, more than the others mentioned here, is very disadvantageous, because the seller really has no hand in whether the buyer’s home sells, unlike the remaining contingencies, to which the seller retains at least some control or certainty.
- Title Contingency
The buyer, to go through with purchasing the property, will want a guarantee that they can receive “clear title,” meaning the title has no potential defects, such as easements, zoning ordinances, and there is no chance that someone will appear and claim to be the “rightful owner” once the property is purchased. This protects not only the buyer, but also the mortgagee, from losing ownership of the property once title passes to the buyer. Ultimately, while the buyer could ostensibly avoid purchasing the property due to a title defect, the seller is entitled to cure any defects until closing, when ownership is transferred from the buyer to the seller.
- Other Terms
Other necessary terms will include a description of the property, and not a description like, “the third house on the right on Oakwood Lane,” but a legal description, which includes a map showing where the property lines lay, the property’s size, and other mathematical data. You can also expect to see some other more nuanced terms, such as whether any appliance, furniture, or other movable property is included in the sale and or purchase price.
As mentioned above, one of the primary purposes in executing a PSA is to outline and agree the procedure that the buyer and seller must act in accordance with to transact the sale and purchase, but what happens when a dispute arises? Dispute resolution procedures should be discussed in the PSA including what procedures are the buyer and seller required to follow when they are unable to agree. Sometimes, an arbitration clause will be included, which requires that the disputed issue be determined by a neutral third-party, known as an arbitrator. Arbitration is more formal than a mediation and usually less formal than a court (and less expensive). Arbitration is like a court, but different from a mediation, in that there is no room for negotiation and the decision made by the arbitrator will be binding on the seller and the buyer.
Beyond the PSA
Once the PSA is executed, both the buyer and the seller (and those that are assisting and/or representing them in the transaction) will engage in numerous activities to conclude the sale and make it a “done deal.” Because real estate transactions are complex, multi-step processes, considerable time can elapse between when the PSA is executed and when the purchaser takes ownership. The contingencies, explained above, protect the buyer in all the processes that now are required take place: an inspection, the title search, executing a loan agreement, paying the buyer, and eventually, closing, when ownership passes from the seller to the buyer.
“Breaching” the PSA
Refusing to go through with the sale—except with respect to a financing contingency when the buyer is unable to receive financing to go through with the purchase—the buyer typically forfeits their deposit. While it may seem that forfeiting the deposit is an extreme penalty, it is important to remember that the seller has expended time and efforts to the exclusion of other prospective buyers. In any event, a court would likely view a deposit as reasonable damages in the event of a breach, provided that the deposit isn’t unusually high (usually a deposit of 5% of the total purchase price or less will be viewed as reasonable).
Special Note on the Purchase Sale Agreement v. Purchase Agreement Distinction
Although the words “purchase” and “agreement” appear in the document known as the “Purchase and Sale Agreement,” a PSA and a “Purchase Agreement,” a PA, are not the same. While both are binding documents, the PSA creates a process to complete the sale and purchase, to which the buyer and seller agree, where the PA completes the transaction.
Where to Get a PSA
As we’ve discussed here, PSAs are something that should be taken seriously given the consequences that can result when a party breaches a PSA. While many websites have PSA’s that can be accessed at no charge or purchased, you should know that some states require that a licensed attorney prepare a PSA. Even if your state doesn’t require that a PSA be drafted by a licensed attorney, you would be well-advised to seek an attorney’s advice prior to entering a PSA or at least considering having an attorney review it.