Ask an Expert: What if a Buyer Backs out of a Contract Before Closing?
Just days before closing, one of real estate agent Grant Lopez’s clients realized he had a problem. The San Antonio homebuyer was suddenly sued over an old car accident and the mortgage lender was no longer willing to provide financing, Lopez said. The buyer had no choice but to back out and cancel the transaction.
Life happens. Real estate transactions do fall apart. LendingTree asked two experts — Lopez, a board member of the San Antonio Board of Realtors, and New Jersey Realtors President Christian J. Schlueter — to walk us through the implications for both buyer and seller.
Can a buyer back out of a real estate contract?
The simple answer is yes. Buyers can back out of a sales contract — and in a small number of cases they do. According to the National Association of Realtors’ (NAR) Realtor Confidence Index for May 2018, surveyed realtors said an average of 5% of contracts were terminated before closing.
A 2017 NAR survey found home inspection/environmental issues and financing problems were the most common reasons a transaction did not complete.
Consequences for the buyer
The more complicated question is not if a buyer can back out, but what consequences will they face for doing so. When a sales contract is signed, most buyers put down a deposit, also known as “earnest money.” This cash is typically between 1% and 10% of the total purchase price and is usually held in escrow until the closing. If a buyer pulls out of a sale, he or she may have to forfeit this deposit to the seller, but it depends on what contingencies are in the original contract.
NAR’S May 2018 survey found that 77% of contracts signed include contingencies, clauses that allow the buyer to walk away under specific conditions and still keep their deposit.
“There are a lot of protections for the buyer under Texas contracts,” said Lopez. “Nine times of 10 when a buyer backs out, it’s usually covered.”
Common contractual contingencies include:
- Issues related to the home inspection
- The buyer’s ability to obtain financing
- The buyer’s inability to sell the prior home
Contracts often include a timeline. For example, the New Jersey standard real estate sales contract gives the seller seven days to correct any defects laid out in the home inspection. If they don’t, the buyer can void the sales contract within seven days without losing their deposit. The New Jersey contract sets out similar timelines related to the buyer’s ability to sell their current property and to secure a mortgage.
As long as the language is in the contract, buyers are able to back out of a home sale penalty-free if they can’t secure a mortgage or sell their homes within set timelines. If you want these contingencies, make sure you get them in writing.
However, there are contractual protections for the seller as well. For example, there is a clause in the New Jersey contract saying the seller can inform the escrowee to hold the deposit if they believe financing fails because of “buyer’s bad faith, negligence, intentional conduct or failure to diligently pursue the mortgage application.”
There are also some state-by-state quirks that give buyers the right to change their decision immediately after signing the contract. In Texas, the buyer can pay the seller a non-refundable fee for an “option” period, usually around 7 to 10 days. This allows the buyer to proceed with the home inspections and negotiate repairs while retaining the option to back out at anytime. In New Jersey and Illinois, there is usually a short attorney review period directly after signing the contract when either party can cancel the deal. Any such rights will be laid out specifically in the sales contract.
Lopez says it’s vital to understand exactly what contingencies are in the contract before you sign and what risks are involved. Read carefully through your sales contract and discuss any questions with your real estate agent or attorney.
Cold feet not covered. Lopez also highlighted one reason a buyer can cancel that isn’t covered by a contingency — getting cold feet. If buyers change their mind about a particular house or making the leap into homeownership, it will cost them. The seller will get to keep the deposit and in rare cases, they could take it even further (more on this below).
Buyers are also responsible for covering fees like home inspections and appraisals, even if the sale is canceled before closing.
Beyond a lost deposit and fees, Lopez doesn’t see much in terms of lasting consequences for a buyer who backs out of a home sale under the terms of the contract.
“Will it hurt if you try and buy again? Probably not,” he said. He thought it was unlikely one canceled sale would cause a mortgage lender to blacklist you. The only blowback you might experience is in a small, local market where real estate agents or sellers might hear that you are unreliable.
The buyer has backed out: now what?
A home sale that doesn’t close can be a frustrating experience for a seller, but the real estate agents we talked to say the vast majority of the time it will happen within terms allowed by the sales contract and its contingencies. The best choice, in these cases, is just to wipe the dirt of your shoulders and start again.
“If it is within terms of the contract, the only option is to put the home back on the market,” Schlueter said.
He also said your agent will go back through the list of potential buyers from the first round of showing your home.
“If the first contract falls through, I would contact the highest backup offer to see if they are still interested,” Schlueter said.
A sale that falls through should not have any impact on the home price going forward. However, Schlueter said, if the sale did not complete because of a home inspection and the seller does not correct the problem, that “could impact the value.” Realtors are required to disclose such information to potential buyers.
In rare cases, a seller may feel the buyer has not held up their obligations under the sales contract. At this point, they may choose to proceed to mediation and/or seek the advice of a lawyer.
Mediation versus arbitration. Mediation is a voluntary process in which a neutral third party helps the buyer and seller resolve their dispute — it’s quicker and less expensive than legal proceedings. The standard sales contract from the Texas Real Estate Commission says the state encourages mediation and any dispute between sellers and buyers which cannot be resolved through talking will be submitted to a mediation service.
A lawyer can advise you if you have valid legal complaints against the buyer and if it’s worth proceeding to arbitration or court proceedings. Schlueter said that in New Jersey, most homebuyers and sellers are already using an attorney and would seek their advice “if they feel something is amiss.”
Still, he said, it’s rare for private real estate transactions to end up in court. “In 32 years of selling real estate, there was only one transaction that appeared headed to court and it was more the seller going after both attorneys for an issue,” he said.
The bottom line
Both buyers and sellers need to read the language in the sales contract carefully. Usually if a buyer backs out, it will be because of an issue with the home inspection or financing and they’ll get back their deposit. If they just have a change of heart, then the seller will usually be entitled to keep the deposit.
Overall, a canceled sale may cost time or money, but the biggest toll may be an emotional one. “It’s already one of the more stressful times in your life when you are buying a house or selling a house,” Lopez said — and the added tumult of a canceled sale can weigh on people.
His advice: it’s a good time to lean on your real estate agent. They’ll be there to answer your questions and see that you get back on track.