The primary penalty for cancelling a real estate contract, particularly if you do not have the right contingency in place, is the forfeiture of your earnest money deposit. This deposit, which demonstrates your good faith in the transaction, typically ranges from 1% to 3% of the home's purchase price, though the exact amount can vary based on market conditions and the property's value.
Understanding Earnest Money Forfeiture
When a buyer decides to pull out of a real estate contract without a valid reason or a pre-agreed-upon contingency, the seller is generally entitled to keep the earnest money deposit. This compensates the seller for the time their property was off the market and any costs incurred.
What is Earnest Money?
Earnest money is a deposit made by a buyer to a seller, showing the buyer's serious intent to purchase a property. It's usually held in an escrow account until closing. If the sale goes through, the earnest money is typically applied to the buyer's down payment or closing costs.
Other Potential Penalties for Buyers
While forfeiture of earnest money is the most common consequence, buyers can face additional legal and financial penalties depending on the specific contract terms and state laws:
- Specific Performance: A seller could sue the buyer to force them to complete the purchase. This is rare but possible, especially in unique market conditions or for custom-built homes.
- Monetary Damages: The seller might sue for additional damages beyond the earnest money, such as costs incurred from relisting the home, storage fees, or a difference in selling price if the home eventually sells for less.
- Legal Fees: Regardless of the outcome, both parties may incur significant legal fees if a dispute escalates to court.
The Role of Contingencies in Real Estate Contracts
Contingencies are clauses in a real estate contract that allow a buyer or seller to back out of the agreement without penalty under specific circumstances. They are crucial for protecting a buyer's earnest money.
Common Buyer Contingencies:
- Inspection Contingency: Allows the buyer to cancel if major defects are found during a home inspection and the seller refuses to fix them or negotiate.
- Financing Contingency (Mortgage Contingency): Permits the buyer to withdraw if they cannot secure a mortgage for the property.
- Appraisal Contingency: Protects the buyer if the home's appraised value comes in below the agreed-upon purchase price.
- Sale of Prior Home Contingency: Allows the buyer to cancel if they cannot sell their current home by a certain date.
If a buyer backs out due to a condition covered by an active contingency, they typically receive their earnest money back. However, if a buyer waives a contingency and then tries to cancel for a reason that contingency would have covered, they risk losing their deposit.
How Contingencies Protect Your Earnest Money
| Scenario | Impact on Earnest Money |
|---|---|
| Cancelling with a valid contingency | Buyer typically receives their earnest money back. |
| Cancelling without a valid contingency | Buyer will likely forfeit their earnest money, which can be 1% to 3% of the home price. |
| Seller default/breach of contract | Buyer typically receives earnest money back and may seek additional damages. |
Practical Insights and Solutions
- Review Your Contract Carefully: Always understand every clause, especially those related to contingencies and default, before signing.
- Don't Waive Contingencies Hastily: While waiving contingencies can make an offer more attractive in a competitive market, it significantly increases your risk.
- Communicate Promptly: If you foresee issues, communicate with the seller or your agent immediately.
- Seek Legal Advice: For complex situations or when contemplating cancelling a contract, consult with a real estate attorney. They can explain your rights, obligations, and potential liabilities under your specific contract and state law.
