Question: We just accepted an offer on our home and wanted to know what can happen to cause a home sale contract to fall through.
Answer: Happy Halloween! In keeping with the Halloween theme, I thought I’d write about something really spooky…home sale contracts falling apart! Now that we’ve returned to more “normal” real estate contracts with standard contingencies, it’s easier for buyers to walk away from a deal without risking their deposit, so let’s talk about some of the common ways buyers and sellers can get out of a deal.
Earnest Money Deposit Seals the Deal
The Earnest Money Deposit (EMD) is a negotiated amount of money that is held in escrow to ensure the Buyer performs their contractual obligations to purchase a property. In the event of Buyer default, some or all of the deposit can be claimed by the Seller for damages. If the Buyer voids the contract using a contingency or other contractual protection, their EMD is protected and returned in full. The amount of EMD is negotiable, but often falls somewhere between 1% and 5% of the purchase price.
For a more detailed explanation of EMD, you can read my May 2021 article on the topic.
How Can Buyers Back Out?
The sales contract stipulates if, and how, the Buyer can walk away from a home purchase without losing their EMD. I’ll highlight the most common protections Buyers have, which are also the most common ways home sale contracts fall through.
Home Inspection: Home inspections are usually completed within one week of being under contract and are the most common reason for deals to fall through. If your contract has a Home Inspection Contingency, it allows a Buyer to void the contract within a specified number of days (usually 3-10 days) and may also provide for a negotiation period after the inspection for the Buyer to negotiate for repairs and/or credits. The Home Inspection gives the Buyer a unilateral option to void and does not allow a Seller to void, only to reject requests for repair and/or credit.
Financing: The next most common way for a deal to fall through is a Buyer failing to secure financing, which can occur for a wide range of reasons. If a Financing Contingency is included in the contract, Buyers can walk away from the deal if they are legitimately rejected for their loan. Buyers are not protected if they self-sabotage their financing, but this can be a grey area and challenging to verify. Depending on the structure and handling of the financing contingency, Buyers may be protected up to the closing date.
The best way to reduce the risk of a deal collapsing from financing is to ensure the Buyer has a strong pre-approval letter from a Loan Officer who has reviewed critical financial info and documents like credit, proof of income, and tax returns.
Appraisal: When a Buyer is taking out a loan to purchase a property, the bank will usually require an independent appraisal from their third-party appraiser pool (in other words, the appraiser comes from the bank, not the Buyer or Seller). The Northern Virginia contract requires Buyers with conventional financing to give the Seller the opportunity to lower the sale price to the appraised value before voiding the contract, but allows the Buyer to void in the event the Seller does not agree to the lower price and Buyer and Seller are unable to reach an alternative agreement. The Northern Virginia contract allows Buyers with FHA, VA, or USDA financing to unilaterally void the contract in the event of a low appraisal, or renegotiate the contract price with the Seller.
Association Document Review: Any time a property is sold within an Association, be it a condo association in a large building or a small HOA cluster of single-family homes, Virginia law requires Sellers to provide a resale package with information about the Association ranging from by-laws, to budget, to the reserve study. In Virginia, Buyers receive a three-day review period of these documents and can unilaterally void the contract within those three days.
The intention of the review period is to provide Buyers an opportunity to review the health, standing, and operations of the association they’re buying into. The reality is that this review period can also be used as a way out for a reason that’s not protected by a standard contingency (e.g. Buyer gets cold feet) because voiding within the review period does not require a specific reason or require that the Buyer allow the Seller to rectify the issue. For this reason, it’s in the Seller’s best interest to have their resale package prepared and available before they accept a contract so the three-day review expires early in the contract period.
Title: The Seller is contractually obligated to deliver title (ownership) of the property to the Buyer that is “good, marketable, and insurable” and in the event the Seller is unable to do so by the closing date, they are in default, which gives the Buyer the right to void the contract. Examples of ways a Seller can’t deliver clean title are unreleased liens (e.g. an unpaid debt to a contractor or unresolved bankruptcy) or an improperly recorded deed (can be a simple clerical/administrative error from past transaction).
How Can Sellers Back Out?
Sellers rarely have a legitimate way of backing out of a sales contract unless the Buyer defaults by not delivering their EMD on time, not applying for financing on time, or does not meet some other contractual obligation.
In the event the contract includes a Home Sale Contingency (Buyer does not have to purchase unless they successfully sell a home), Sellers have a kick-out clause which allows them to notify the Buyer of their intent to void the contract within a specified period if the Buyer does not have a ratified contract on the property they’re selling or cannot otherwise remove the Home Sale Contingency. This is the closest most Northern VA contracts get to allowing the Seller to void, and even that is not common.
How Is EMD Handled If Deal Is Voided?
If a Buyer voids under the contractual protections of a contingency, association review period, or seller default they are due 100% of their EMD. If a Buyer walks away from a deal outside the legal protections of the contract, the Seller may make a claim on their EMD.
In any case, whether the Buyer is protected or has defaulted and the Seller has a legitimate claim on the EMD, no money can be released to either party without both parties signing off on the amount(s) to be released to each party.
It’s rare for there to be a conflict over the release of EMD back to the Buyer if they are legally voiding a contract, but there can be conflict when a Buyer defaults/walks without contractual protections and the Seller makes a claim on the EMD. This can turn the EMD release into a negotiation and in the (unusual) scenario that the release cannot be agreed upon by both parties, legal action is required to resolve the distribution of the deposit. The Title Company, the party that often holds the EMD, can be an informal mediator but cannot make any legally binding decisions about how EMD is distributed, no matter how strong or weak the case is for each party.
If you’d like to discuss buying, selling, investing, or renting, don’t hesitate to reach out to me at Eli@EliResidential.com.
If you’d like a question answered in my weekly column or to discuss buying, selling, renting, or investing, please send an email to Eli@EliResidential.com. To read any of my older posts, visit the blog section of my website at EliResidential.com. Call me directly at (703) 539-2529.
Video summaries of some articles can be found on YouTube on the Ask Eli, Live With Jean playlist.
Eli Tucker is a licensed Realtor in Virginia, Washington DC, and Maryland with RLAH @properties, 4040 N Fairfax Dr #10C Arlington VA 22203. (703) 390-9460.