Real Estate Contract Penalty Clauses

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 What is Real Estate and Property Law?

Real estate and property laws cover a wide variety of topics, which include doing the following with residential or commercial property:

  • Buying;
  • Selling;
  • Using; and
  • Leasing.

Common disputes involving real estate and property law include:

Real estate and property laws also govern the financial aspects of real property, including:

In addition, wills and trust laws may be included in the broad category of real estate and property law but those laws may also be separated into their own minor subtopic of estate law.

What is a Contract?

Contracts are agreements between two private parties which create mutual legal obligations between those parties. Contracts may be oral or they may be written.

Oral contracts, however, are more challenging to enforce and should be avoided whenever possible. Certain types of contracts must be written in order to be valid, including contracts which involve a significant amount of money, which is usually over $500.

Contracts are typically part of everyday dealings regarding all aspects of life. Because of this, it is important to understand the rules which govern contracts in order to ensure a contract is valid.

In order for a contract to be valid and enforceable, it must include the following elements:

  • An offer, such as an individual will pay a baker $1,000 for 1,000 cupcakes;
  • And acceptance of the offer presented, such as the baker accepts $1,000 for 1,000 cupcakes;
  • A promise to perform, where the baker says they will perform;
  • A valuable consideration, the buyer pays $1,000;
  • A time or an event of when the performance must be made, such as 1,000 cupcakes ready exactly 2 weeks from today;
  • Terms and conditions for the performance, such as the cupcakes must be chocolate and have vanilla frosting; and
  • Performance, which occurs when the 1,000 cupcakes are delivered and the baker is paid $1,000.

In addition, courts will not enforce certain types of contracts unless they are in writing if they fall under the Statute of Frauds. Contracts which fall under the Statute of Frauds include:

  • Marriage contracts;
  • Contracts not to be performed within a year;
  • Interest in land contracts;
  • Contracts to pay a decedent’s debt; and
  • Contracts for the sale of goods over a specific amount.

The majority of contracts are governed by state statutes. Because of this, it is important for an individual to consider local laws if they have a contract issue.

What are the Required Elements for a Contract?

There are five main elements which are required for any type of contract. First, a contract is required to have a legal purpose, meaning that it cannot be used for an illegal purpose.

For example, a contract cannot be made to commit a crime, such as hiring a hitman. Second, the parties must have a mutual agreement.

This component is also referred to as the meeting of the minds. For this component, one party is required to have made an offer to another party for acceptance.

For example, when a contract is signed, it shows that there is a mutual agreement between the parties and that all of the parties are on the same page. There are some offers which may not have an expiration period, which means that the offer will remain open for a reasonable time.

An offer may also be revoked until acceptance occurs. Acceptance typically means agreeing to the terms of an offer.

If any changes are made to the terms in the acceptance, it is considered a counteroffer. It is important to note that states do differ on this issue so it is ideal for individuals to consider the regulations in their local jurisdiction.

Third, in order for the contract to be valid, there must be consideration. Consideration is given when both parties agree to provide something of value in exchange for some benefit.

Consideration may include:

  • Manual labor;
  • A vehicle;
  • Money; or
  • Other things of actual value.

It is important to note that there is also a difference between a gift and a promise. For example, if an individual gives another individual a handbag, it is not considered a contract.

This is the case even if an individual promises to give another individual a handbag but they do not. However, a contract does exist if an individual exchanges a handbag for another individual completing a task.

For example, if one individual says if their friend cleans their gutters, they will purchase them a handbag. Fourth, the parties to the contract must be legally competent.

A minor or a mentally impaired individual cannot enter into a contract. In addition, the parties to the contract must be of sound mind while contracting and they cannot be under the influence of drugs or alcohol.

Fifth, the parties to the contract must come to an agreement of their own volition. A contract will be void if there is:

  • A mistake;
  • Duress; or
  • Fraud by one or more parties.

What Are Real Estate Contract Penalty Clauses?

A penalty clause in a real estate contract typically imposes a penalty upon the mortgage lender or borrower if they violate certain terms of the contract. In the majority of cases, the penalties are imposed by a mortgage lender upon a borrower, although this may differ depending upon the contract terms.

One of the most common types of penalty clauses is called a prepayment penalty clause. This is a penalty clause which is imposed on a borrower if they attempt to make a mortgage payment prior to the date or time period which is stated in the contract.

Although it may seem that a mortgage lender would prefer an early payment, in certain cases, a lender may lose profits if a mortgage is paid off too quickly. Because of this, a mortgage lender may require a borrower to make their payments in regular, cyclical payments, and not earlier.

In some cases, an early payment may result in a penalty being imposed on a borrower, which may include a monetary fee.

Are Penalty Clauses Enforceable?

A prepayment penalty clause is only enforceable if both the borrower and the lender agree to the terms which are stated in the clause. A prepayment clause is, in most cases, embedded as an included clause in the original mortgage contract.

Therefore, when a borrower signs their mortgage loan documents, they must be informed if there is a penalty clause in the contract. If a prepayment clause is not included in the original contract or if a party does not agree to the clause, it is not enforceable under real estate and contract laws.

In these cases, a violation would not result in a penalty for a lender as the penalty was not enforceable to begin with.

What if a Penalty Clause is Violated?

If a penalty clause is executed correctly, both the borrower and the lender may face legal consequences if they violate the terms of the clause. For example, if a borrower makes an early payment, the lender has a legal right to enforce a penalty according to the clause.

If the borrower does not pay the penalty fees which are assessed, the lender may take them to court and sue them for those penalty payments. This is because a penalty clause is subject to basic contract principles and, as such, a violation of the penalty clause would be remedied in a manner which is similar to a breach of contract claim.

Do I Need a Lawyer for Help With a Real Estate Contract Penalty Clause?

It is essential to have the assistance of a contract lawyer for any issues, questions, or concerns you may have related to a real estate contract penalty clause. A real estate contract is extremely important for all parties who participate in the real estate transaction.

A penalty clause is a common aspect of many real estate contracts. You can contact a lawyer for guidance if you need a penalty clause:

  • Drafted;
  • Reviewed; or
  • Edited.

Your lawyer will explain how penalty clauses can affect your real estate transactions. If a violation or a dispute arises, your lawyer will be able to provide you with representation in court.

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