Backing out of a real estate transaction is not as uncommon as you might think. According to the National Association of REALTORS® (NAR) Realtor Confidence Index report, around 5% of real estate contracts are terminated before closing.
Usually, buyers terminate contracts because of problems with their financing, unexpected home inspection results or appraisal issues. So, what happens when a buyer backs out? Let’s lay it all out:
Consequences of backing out
While a buyer can legally back out of a home contract, there can be consequences for doing so. For example, you can lose your earnest money, which could amount to thousands of dollars or more.
That is unless your reason for pulling out of the deal is stipulated in your contract.
Earnest money is used to show that the buyer is going into the contract in good faith. The money is held in an escrow account until closing by a third party such as a title company.
If you back out of the deal and do so for a reason that was not explicitly included in the contract, you could be out your earnest money.
Contingencies and backing out
Contingencies are basically clauses in real estate contracts that lay out conditions for the contract’s completion. Contingencies exist because there are a lot of unknowns in both buying and selling a home.
A buyer usually doesn’t know how the home inspection will turn out when they put in an offer. Likewise, the seller usually doesn’t know if the buyer will be able to secure proper financing when they accept an offer.
Contract contingencies protect both parties from these unknowns. Most real estate contracts include contingencies that protect both the buyer’s and seller’s interests.
The most common contingencies in real estate contracts are:
- Home inspection
- Getting an acceptable appraisal
If you back out of a contract, but you’re protected by a contingency, your earnest money should be safe. Further, state laws can also protect buyers in real estate transactions.
Ultimately, it always depends on the terms of your individual contract and the laws of the state where you’re doing business.
Make sure you thoroughly understand your contract before signing. If you have questions about your contingencies, ask your real estate agent or lawyer for further guidance.
What About Cold Feet?
Much of the time, when buyers back out for good faith reasons, they’re covered by the contract.
Unfortunately, the vast majority of contracts don’t have a “cold feet” opt-out. Keep that in mind before you put down your earnest money.
If you back out because of cold feet, you’ll likely lose your deposit. And if you’re buying in a pricey market, that could amount to tens of thousands of dollars.
Tips to protect yourself
It’s always important to protect yourself when it comes to entering into—or backing out of —a real estate contract. Here are a few tips to help:
- Read your contract thoroughly before signing. Make sure to pay special attention to contingencies.
- Use a lender with an earnest money guarantee. Compare lenders and find out if any of your options offer an earnest money guarantee.
- Pay attention to contract timelines. Contingencies often have timelines. For example, a contract might stipulate that the seller has up to 10 days after the home inspection to fix any defects. If the defects aren’t fixed in time, the buyer has the right to walk away with their deposit money. Make sure you understand these timelines before entering into your contract.
- Know your state law. Each state has its own law governing contracts. Your state’s law can affect your real estate transaction. For example, in Illinois, there is a short period of time after signing a contract where either party can review with an attorney and cancel the deal. Do a little research into your state’s contract law to find out what protections you might have as a buyer.
Entering into a purchase contract to buy a home is one of the biggest decisions a person can make and shouldn’t be taken lightly.
We recommend contacting a real estate professional or attorney with any questions you may have in relation to the purchase of a home.
Header Image Source: (Isabela Kronemberger/ Unsplash)