What you need to know about backing out of a home purchase when you’re under contract

If you’re a prospective homebuyer who is having second thoughts, you’re not alone.

About 15% of all home contracts fell through in June, marking the highest share of cancellations since March 2020 — the start of the pandemic — when it was 17.6%, according to real estate brokerage Redfin. A year ago, the share was 11.2%.

Yet before you join the ranks of buyers who walk away from a deal in progress, it’s important to consider if it will cost you to do so. Or, if you have yet to sign an initial contract but are nearing that point, it’s worth knowing whether you can cancel at some point in a way that wouldn’t result in forfeiting your deposit.

Typically, buyers provide what’s called an earnest money or “good faith” deposit when an offer is made on a home, although the specifics vary from state to state. The amount is usually 1% to 5% of the purchase price but can run as high as 10% depending on the local market.

The deposit is kept in an escrow account and goes toward your down payment or other closing costs when you finalize the purchase at settlement.

If the seller accepts your offer and you sign a purchase agreement — whether weeks or months before settlement — you can risk losing that deposit if you try to get out of the contract without meeting the terms.

Given the financial risks of a broken contract, it makes sense to ensure the final purchase is contingent upon certain aspects of buying a house. Common contingencies relate to home inspection, appraisal and financing.

For example, if the inspection were to reveal problems with the house that are unacceptable to you, a home inspection contingency generally would mean you can walk away and get your deposit back. Or, if the appraisal were to fall short of the agreed-upon sale price or you cannot secure a mortgage at a rate or terms specified in the contract, you could back out without losing your money.

Be aware, though, that the process and conditions for being able to recoup your deposit differs from state to state, said Erin Sykes, chief economist for Nest Seekers International, a real estate brokerage.

Several trends may boost the share of canceled agreements.

“Buyers are putting contingencies back in [purchase agreements] … and not giving it all away to sellers like they did a month ago,” said Stephen Rinaldi, president and founder of Rinaldi Group, a mortgage broker.

As for why buyers are backing out, it may be due to home inspections that failed to pass muster with the buyer — or at least gave them an out.

“They may be pulling out because of inspection contingencies … they may think they can cancel the deal now and then get a better deal on this property or another in the coming months,” Sykes said.

“But we don’t know how much the market is going to change,” she said.

There also may be affordability issues causing buyers to walk away, especially in new construction, said Al Bingham, a mortgage loan officer with Momentum Loans in Sandy, Utah.

Basically, with home builders facing material shortages, new houses are taking longer to complete. This means that the current interest rate available to a buyer ahead of settlement may be higher now than it was before construction started.

Buyers “are willing to walk away even if they can qualify because the house payments have gone up,” Bingham said. “They just cannot afford it.”

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After two years of surging home prices, rising interest rates have tapped the brakes on a red-hot housing market. The average fixed rate on a 30-year mortgage was 5.3% as of last week, up from about just above 3% in early January, according to the Federal Reserve Bank of St. Louis.

For illustration: A 5.5% fixed interest rate on a 30-year, $500,000 mortgage would result in principal and interest payments of $2,839 monthly. That amount does not include other costs that often are wrapped into mortgage payments, including homeowners insurance, property taxes or private mortgage insurance.

If that rate were 3% — where it was at the start of 2022 — the principal and insurance payment would be $2,108.

“The market shifted really fast,” Rinaldi said. “It went from people offering $40,000 above asking price, waiving inspections, promising their first-born … to not so much, because rates increased so fast.”