A letter of intent is a precursor to a purchase agreement. Instead of generating a purchase agreement as an offering document, some buyers will send a much shorter LOI to outline the business terms of their offer and to gauge the seller's interest. If both parties can work out the terms, they will generate a full contact. LOIs can save time and money, but they also bring with them the potential for legal complications.
In real estate, a letter of intent assures both parties of any business terms of their offer.
Exploring Elements of an LOI
A letter of intent has many of the same elements as a purchase agreement. Most LOIs specify a purchase price and a time frame for closing. They also usually specify which inspection contingencies the buyer will need and how long they will need to remove them. The key difference between an LOI and a contract is that LOIs are usually much shorter, containing less precise legal language. LOIs also do not require an earnest money deposit.
Binding and Non-Binding LOIs
LOIs can be written to be binding or to be non-binding. With a binding LOI, once the two parties sign it, the property goes off of the market while they work out the terms of a full-fledged purchase agreement. Non-binding LOIs are almost the same thing as a memo outlining a conversation. The two parties agree on the terms of the sale, but haven't agreed to work with each other. As such, the seller could accept a different LOI and the buyer could walk away at any time until the purchase agreement gets signed.
Identifying the Benefits of LOIs
LOIs have two key benefits. They are usually much faster and less expensive to draft than purchase agreements. This is especially salient in markets where attorneys usually get involved in drafting purchase agreements, which can both slow down the process and make it more expensive. For buyers that make multiple offers, LOIs have the benefit of not requiring earnest money checks. This lets the buyer keep control of their money until they know that they have a deal that works for them and the seller.
Drawbacks to LOIs
The LOI has two key drawbacks. The first is that it introduces another step into the negotiation process. Instead of going right to a contract, the two sides negotiate business terms then have to go back and re-negotiate everything when they generate the contract. This is time consuming and, if an attorney is involved for both documents, potentially expensive.
LOIs also have an unclear legal status. When you have a purchase agreement, you know where you stand legally. With an LOI, you frequently have a document that meets the legal standard to be a contract, but you don't call it a contract. At times, a court will consider it a contract. As such, a non-binding LOI could actually be a binding purchase agreement. It's hard to be sure of how a court will rule until a problem comes up.