Posted by Trey Van Tuyl on Friday, July 19, 2019 at 4:22 PM By Trey Van Tuyl / July 19, 2019 Comment
You may be wondering how a buyer or seller is able to back out of a real estate transaction. Perhaps you’re under contract and looking for a way out or wondering how the other party could abandon the contract. Regardless, we are going to detail how both a buyer and seller are able to successfully back out of a real estate contract.
Can a buyer back out of a real estate contract?
A buyer can absolutely back out of a real estate contract. According to the REALTORS® Confidence Index, around 5% of real estate purchase contracts are canceled by the buyer for a variety of reasons. The easiest and most convenient way for a buyer to cancel a real estate contract is through contingencies, but other methods are still possible.
Let’s dig into popular methods that buyers can use to back out of a real estate contract:
Method #1: Prior to Binding
A buyer is able to rescind their offer before it is accepted. While the buyer may have signed and delivered their offer, the terms are not binding until all parties sign the contract. Prior to all parties signing the document, the buyer (or seller) is able to give notice that the offer is withdrawn without facing any consequences.
Method #2: Due Diligence Contingency
The due diligence period is by far the most common way that buyers are able to back out of a real estate contract. Most purchase and sale contracts include a due diligence period (also called the option period) where the buyer is able to cancel the contract for almost any reason. This period typically begins immediately after all parties sign the contract and lasts for a defined period of time, usually between 7 to 14 days.
Here are some reasons why buyers cancel during the due diligence period:
- Something came up during a home inspection that makes the home undesirable.
- The seller and buyer could not come to an agreement stemming from repairs.
- The home may be uninsurable due to extensive damage.
- The HOA rules may be unacceptable by the buyer.
- An undesirable feature of the neighborhood is discovered. Perhaps the home is underneath a common flight path, nearby a bus stop, or located near sex offenders.
- A sudden life event which changes the buyers’ financial or emotional health. Could include job loss, unplanned pregnancy, or a sudden death in the family.
- The buyer may need to extend the due-diligence period and the seller refuses.
- Another home is put on the market that the buyers prefer.
- Cold feet. For whatever reason, the buyer regrets signing the contract and wants to back out.
In many states, a buyer can cancel during the due diligence period without even specifying a reason. It’s basically a “no questions asked” way for buyers to back out without any repercussions. Any earnest money put down will be returned and the sellers will be left with no other option but to find another buyer.
Keep in mind though that the contract must include a due diligence period for this to be an option. Due diligence contingencies aren’t usually granted when the home is being sold “as-is”.
Method #3: Loan Contingency
Buyers who are looking to borrow funds in order to finance the purchase of their home include a loan contingency in their purchase contracts. Even with a pre-approval letter, a buyer may be unable to receive final approval for a loan. The loan contingency allows the buyer to cancel the contract in the event they are unable to secure financing for the home. The loan contingency specifics the time period during which a buyer can successfully cancel the contract.
A buyer can only use the loan contingency to back out a purchase and sale agreement if they are denied for a loan. This is different from the due diligence period where a buyer is able to cancel for practically any reason. The buyer may be obligated to provide a “Loan Denial Letter” to the seller, which is an official letter from a lender proving that the buyer was unable to obtain a loan.
The buyer is able to have their earnest money returned and walk away without penalty in the event they exercise the loan contingency. Issues related to obtaining financing are the most common reason why closing is delayed or a real estate contract is canceled.
Method #4: Appraisal Contingency
A buyer may be able to cancel the contract if they have an appraisal contingency and an agreement on price cannot be reached. An appraisal contingency allows the buyer to hire a certified appraiser to provide an appraisal of the property. Most lenders require that a home appraisal takes place.
In the event the appraisal is below the agreed-upon purchase price of the property, the buyer has the option to request that the sale price be lowered to the amount the property appraised at. The seller can deny this request or negotiate some sort of mutually agreeable solution. In the event there isn’t an amicable solution, the buyer has the right to cancel the contract and walk away with their earnest money.
Keep in mind that the buyer has a limited amount of time to back out of the contract under this contingency. There’s a contractually defined period when the buyer is able to conduct an appraisal and request a reduction in price.
The seller is typically incentivized to negotiate when appraisal issues arise because over 75% of buyers finance their homes through a loan. This means that the same issue will very likely arise with a future buyer.
Method #5: Home Sale Contingency
The home sale contingency allows a buyer to back out of a contract in the event that their current home does not sell or lease. Once the contingency period ends, if the buyer’s house is not sold or leased the entire purchase and sale contract is terminated and the buyer receives their earnest money back. This contingency can be waived by the buyer prior to the contingency period ending, having it be no longer applicable to the sale.
It’s technically possible for a buyer to utilize the home sale contingency to their advantage. Imagine a buyer who is in no rush to sell or lease their home and lists it on the market for a price above market value, meaning the home is unlikely to sell quickly. The buyer then has the ability to either waive the contingency and allow the sale to take place or cancel the contract due to their home “not selling” and receive their earnest money back. Cases such as these are rare, but allow a buyer a considerable amount of flexibility on a purchase.
Method #6: Title Clouds
Every purchase and sale agreement in real estate includes some sort of language which states that the seller will deliver the home “free and clear of any encumbrances”. The buyer is able to cancel the contract and receive back their earnest money in the event the seller is unable to deliver the home without a clean title.
Method #7: Defaulting
Buyers can technically cancel the contract whenever they desire, but doing so outside of a contingency or contractually acceptable manner opens them up to legal ramifications. When a buyer cancels a real estate contract outside of a contractually sanctioned method, they are said to be in default.
Buyers open themselves up to a considerable amount of risk when they default on their agreements. The following remedies may be available to the seller in the event that the buyer breaches the contract:
- Keep the buyers’ earnest money (usually 1-10% of purchase price)
- Sue the buyer for breach of contract
- Sue the buyer for specific performance
The seller is only able to pursue one remedy at a time but can pursue other remedies in the event that one fails. In most cases, the seller will simply accept the earnest money as compensation for the time the home was off the market and relist the home. Your contract may have a “liquidated damages” clause which states the earnest money is the maximum amount of funds the seller is entitled to.
It’s in the buyers’ best interest to remain transparent about why they are unable to fulfill their contractual obligations. Whether it be personal matters or a sudden change in their financial situation, most sellers are cooperative and may even be willing to graciously let a buyer default without financial consequence. If you find yourself in this situation, contact a real estate attorney to review your available legal options.
Can a seller back out of a contract?
There are a number of ways in which a seller is able to back out of a home sale. It’s not too common considering that buyers’ remorse is more common of a phenomenon than sellers’ remorse, but it still can happen. Here are some ways that sellers can cancel a real estate contract:
Method #1: Contingency
Sellers can place a contingency within a purchase and sale contract which allows them to back out without any penalty whatsoever. This contingency would be comparable to a buyers’’ “due diligence” period, as the seller can exercise this contingency for any reason whatsoever. Such “escape hatches” are uncommonly for sellers but remains an option for them.
Method #2: Kick-Out Clause
Many home sale contingencies have a special provision called a “kick-out clause”. This clause permits sellers to keep their home on the market and continue showing it despite being under contract with a buyer. The sellers can continue to accept offers and ultimately “kick out” (cancel) the initial contract in the event that they receive a better offer.
The kick-out clause benefits sellers because it allows them to mitigate some of the risks associated with a home sale contingency. As previously detailed, there are some ways that buyers can use the home sale contingency to their advantage. The “kick out” clause helps to mitigate these added risks by allowing the seller to continue their search for a better offer. If a better offer comes along, they request that the buyer remove their contingencies and put down more earnest money. If the buyer refuses to do so, the seller can cancel the contract without any penalty and accept the new offer.
Method #3: Forcing Buyers’ Hand
A seller can effectively cancel a contract in the event that they are unwilling to do something that the buyer requests them to do. By doing so, they can force the buyers’ hand to cancel the contract.
Let’s assume the buyer enters into a contract with a due diligence contingency and finds that the home has an infestation of toxic mold. The buyer receives a remediation estimate and requests a discount on the closing price so that the buyer can fix the mold issue after closing. The seller then refuses this request and tells the buyer that they are unwilling to grant any concessions. A buyer is unlikely to find such a scenario as acceptable and will cancel the contract within the due diligence period.
A seller can also have the same attitude if the buyer requests a price reduction via an appraisal contingency. The seller could simply refuse to lower the price in any circ*mstance, leaving the buyer likely to walk away and cancel the contract.
Method #4: Default
At the end of the day, the seller can simply cancel the contract without proper justification and be in default. However, they are exposing themselves to the same risks that buyers’ face when canceling a contract without cause.
Buyers can sue the sellers for specific performance and force the sale of the home through the courts. Buyers generally have a better case of winning a specific performance lawsuit than do sellers. Buyers can also sue for damages, particularly for the money they spent anticipating the sale of the home. This could be funds spent on temporary housing, furniture storage, or inspections.
However, buyers may walk away without filing suit if they can retain their earnest money. At the end of the day, getting wrapped up in a potentially multi-year lawsuit isn’t appetizing for buyers or sellers. A seller may also be willing to chip in a certain amount of money to help compensate the buyer for their expenses.
Conclusion
The easiest and least expensive way for a buyer or seller to back out of a real estate contract is through contingencies. Any buyer or seller should incorporate adequate contingencies into their offer if they suspect there is any chance that they may need to back out in the future. Defaulting should be a last resort measure reserved for dire circ*mstances.
