Key Takeaways
- An LOI is non-binding and outlines deal terms; the PSA is the legally binding contract governing the transaction.
- A valid PSA requires parties, property description, price, terms, contingencies, closing date, and signatures.
- Earnest money (1-3% residential, 3-10% commercial) demonstrates buyer commitment and is held in escrow.
- Earnest money is the buyer's primary financial risk — understanding refundability conditions is essential.
The contract is the legal backbone of every real estate transaction. From the initial letter of intent to the fully executed purchase and sale agreement, each document creates rights, obligations, and deadlines that control the deal from offer through closing. Earnest money — the deposit that accompanies the contract — signals buyer commitment and becomes the primary financial risk during the contract period.
LOI vs. Purchase and Sale Agreement
A Letter of Intent (LOI) is a non-binding document that outlines the key business terms of a proposed transaction — price, closing date, due diligence period, and major contingencies. LOIs are standard in commercial real estate, where they serve as a framework for negotiation before attorneys draft the formal contract. In residential transactions, buyers typically skip the LOI and submit a binding offer directly.
The Purchase and Sale Agreement (PSA) is the legally binding contract that governs the transaction. A valid PSA must contain several essential elements: identification of the parties (buyer and seller), legal description of the property, purchase price and payment terms, contingencies and conditions, closing date, and signatures of all parties. State law governs contract requirements, and most states require real estate contracts to be in writing under the Statute of Frauds. Missing any essential element can render the contract unenforceable.
Why it matters: Under the Statute of Frauds (adopted in all 50 states), contracts for the sale of real property must be in writing and signed by the party to be charged. Oral agreements to buy or sell real estate are generally unenforceable, regardless of witnesses or partial performance.
Earnest Money: Purpose, Amounts, and Escrow
Earnest money (also called a good faith deposit) demonstrates the buyer's serious intent to complete the purchase. The deposit is submitted with the executed contract and held in an escrow account by a neutral third party — typically a title company, attorney, or broker. Earnest money is not an additional cost; it is applied toward the purchase price at closing.
Residential earnest money deposits typically range from 1-3% of the purchase price, though competitive markets may push deposits to 5% or higher. Commercial transactions often require 3-10% deposits depending on deal size and seller requirements. The timing of the deposit varies by market and contract terms — some require deposit within 24 hours of contract execution, while others allow 3-5 business days.
Earnest money becomes the buyer's primary financial risk during the contract period. If the buyer defaults (fails to close without exercising a valid contingency), the seller may be entitled to retain the earnest money as liquidated damages. Conversely, if the buyer properly exercises a contingency (e.g., cancels due to failed inspection), the earnest money is refunded in full. Understanding exactly when and how earnest money becomes non-refundable is critical to managing transaction risk.
| Transaction Type | Typical Earnest Money | Deposit Timing | Escrow Holder |
|---|---|---|---|
| Residential (standard) | 1-3% of price | Within 3 days of acceptance | Title company or broker |
| Residential (competitive) | 3-5% of price | Within 24 hours | Title company or attorney |
| Commercial (small) | 3-5% of price | Within 5-10 business days | Title company or attorney |
| Commercial (institutional) | 5-10% of price | Per PSA schedule (often staged) | Escrow agent or attorney |
Earnest money norms by transaction type
Why it matters: Understanding this concept is essential for making informed investment decisions.
Key Takeaways
- ✓An LOI is non-binding and outlines deal terms; the PSA is the legally binding contract governing the transaction.
- ✓A valid PSA requires parties, property description, price, terms, contingencies, closing date, and signatures.
- ✓Earnest money (1-3% residential, 3-10% commercial) demonstrates buyer commitment and is held in escrow.
- ✓Earnest money is the buyer's primary financial risk — understanding refundability conditions is essential.
Sources
- Statute of Frauds — Real Property Contracts(2025-01-20)
Common Mistakes to Avoid
Depositing earnest money before fully understanding the refundability conditions in the contract.
Consequence: The buyer may forfeit their deposit (1-10% of purchase price) if they need to cancel for a reason not covered by the contingencies, resulting in significant financial loss.
Correction: Review every contingency clause, deadline, and refundability trigger in the PSA before depositing earnest money. Know exactly when the deposit becomes non-refundable ("going hard").
Submitting a binding offer in a commercial transaction without first negotiating through an LOI.
Consequence: The buyer commits to binding terms before key business points are resolved, potentially locking in unfavorable conditions that are difficult to renegotiate once the PSA is executed.
Correction: In commercial transactions, always negotiate the LOI first to resolve price, terms, due diligence period, and major contingencies before attorneys draft the binding PSA.
Test Your Knowledge
1.What is the key difference between a Letter of Intent (LOI) and a Purchase and Sale Agreement (PSA)?
2.What is the typical earnest money deposit range for a commercial real estate transaction?
3.Under the Statute of Frauds, what is required for a real estate sales contract to be enforceable?