Fall Real Estate 2002

Publication Date: Wednesday, October 16, 2002

Risky business
Backing out of a real estate deal can cost big time

by Rachel Metz

When Matt and Julie G. began finalizing plans to buy their first home in Menlo Park in March 2000, they thought everything would run smoothly from loan negotiations to moving in their furniture.

The seller was asking $1.15 million, and knowing they were competing with several other bidders Matt and Julie offered to pay $1.6 million with no contingencies, such as property inspections or appraisals, on the house.

After putting down a $48,000 deposit, Matt's stock in his Menlo Park software company went down 75 percent from about $160 a share to about $40 a share within a three-week period. Victims of a volatile stock market, the couple suddenly found themselves without enough equity to cover the costs of purchasing that home and pulled out of the contract during the last week before the deal would close.

"We couldn't make the large down payment we wanted to make," Julie said.
The seller, who Julie said bought the home in the 1970s for $150,000, refused to give Mark and Julie their deposit money and eventually the second-highest bidder bought the home for $1.45 million.

"We tried to kind of plead with (the seller) and say, 'We're a new couple, we're about to get married,' but he was a jerk; he just said, 'no,'" Julie said. "His point was, 'When you locked me into this contract in March 2000 things were more on fire than when I had to put it back on the market.'"

Typically, homebuyers make a deposit of a percentage of the house's purchase price once the seller accepts their bid. Palo Alto-based Coldwell Banker real estate agent Vic Spicer said once contingencies made on the initial contract are met and signed off on, the buyer is usually required to increase the deposit to 3 percent of the sale amount.

This deposit, often called "at-risk" money or a "liquidated damages deposit," serves as a form of insurance for the seller and in theory, said Atherton-based Loanlane real estate broker Mark Leaver, most or all of the deposit money would go to them in the rare event a buyer reneges on a contract. He said a buyer who lands in a sticky financial situation could ask the seller to renegotiate the terms of the contract in order to complete the purchase, but the possibility of a seller agreeing to change contract terms is unlikely.

Though agreeing to purchase a house and then going back on the agreement creates a messy situation in which the buyers could lose their entire deposit, this situation is uncommon, Leaver said. He estimated less than 1 percent of home real estate contracts in California end in forfeiture on the part of the buyer.

"If you make a contract to buy a house, you really want that house and the last thing you want to do is not secure your down payment," Leaver said.

Spicer estimated up to 5 percent of local potential homebuyers - including several he has worked with - renege on real estate contracts for a variety of reasons. He said the contingencies often agreed upon between buyer and seller can help the buyer if they are suddenly unable to fulfill the terms of the contract and have not yet signed off on the contingencies.

"If they've got a really strong reason there's a good chance the seller is going to cooperate with them, refund their money and let them go on their way," he said.
If a seller does not want to give the buyer back the deposit Spicer said the case could become a legal issue wherein a judge would arbitrate the case and decide if the seller should get some or all of the deposit.

Of a seller recouping deposit money, Spicer said, "The court might require the seller to prove they had a loss. The seller might have to prove they spent a lot of money advertising the property, paying for the mortgage. ... It's not cut-and-dried by any means what's going to happen."

As for real estate agents working with buyers who suddenly pull out of a home-buying contract, Spicer said they make no commission on the sale and in extreme situations may take the buyer to court in efforts to claim some money.

"No two circumstances are ever the same," he said.

To avoid a sudden loss of equity potential homebuyers with assets tied up in stocks could turn those virtual funds into liquid funds or secure interest-yielding accounts, such as money market accounts, after agreeing to purchase a home, Leaver said. That way, the risk of losing a down payment is quelled and buyers can be sure in two months they'll be able afford the house they initially decided on.

"Most of the buyers realize that in order to make their transaction work they have to convert any funds they currently have...into cash as soon as possible. So most buyers go into the transaction fully aware of that and they wouldn't play the risk game of leaving their down-payment money in the stock market once they've signed a real estate contract because there's too much risk involved," Leaver said.

Often buyers now require sellers get pre-approved for loans - that is, get a green light from a bank that says they will back the buyer with a loan if they decide to apply for one, Leaver said. That way, the seller can feel more secure the buyer will be able to follow through on a home deal.

Considering the current economic lows and an ever-changing stock market, many would-be homebuyers simply drop out of the hunt if they suddenly don't have the finances to purchase in the area they're interested in, Leaver said. Economic sluggishness may also be contributing to an increase in buyer defaults, Spicer said.

"They're deciding to no longer look and that is why you're seeing houses that are on the market longer now," Leaver said.

After losing their deposit Matt and Julie continued to search and in May 2000 found a smaller home in Palo Alto.

"I was determined so with our same agent. I found a much more modest but adorable two-bedroom, two-bath (house) in Palo Alto that turned out to be a better location for us in the end," Julie said.