NOTE: This article is not intended to be legal or financial advice, and is provided for information purposes only. Please consult a lawyer as soon as possible if you are facing the possibility of not closing on a transaction.
The question of what happens when a house sale falls through is something we’re explaining more and more often as Ontario’s real estate market continues to face turbulence.
The pandemic significantly impacted the housing sector, with prolonged restrictions and stay-at-home mandates causing many Ontarians to reconsider their living arrangements. This surge led to rapid home price escalations across the province, with some areas seeing a staggering 70-80% increase and no major market experiencing less than a 30% rise.
But now, after a period of exceptional growth, Ontario’s once-booming real estate market has cooled off…
The post-pandemic era has introduced a new challenge: high inflation and corresponding high interest rates. Inflation peaked at a 40-year high of more than 8%, causing the Bank of Canada’s reaction through stricter policies and higher rates.
This one-two hit has pushed many buyers out of the market, stretching housing affordability to its limits. On the selling side, this has resulted in lower property values and longer days on market — something not seen in a very long time for most of Ontario.
Why Do People Fail to Close Their Real Estate Transactions?
Rising Interest Rates Lead to Buyer’s Remorse
As home buyers approach their closing dates, soaring interest rates have resulted in significant hikes in monthly mortgage payments — sometimes by hundreds or even thousands of dollars. While some buyers may absorb these costs and proceed, others find themselves unable to afford the increased payments and are compelled to withdraw from the transaction.
Even those who can manage the payments might opt to back out if the cost of doing so is lower than proceeding with the transaction.
Mortgage Approval Challenges
Before approving a mortgage, banks use a stress test to assess whether buyers can handle potential increases in interest rates beyond the initial mortgage rate.
As policy rates rise, so does the qualifying rate for the mortgage stress test. Ontarians currently face a qualifying rate of roughly 2% more than the actual interest rates.
Example: Mandy is buying a $500,000 home with a $50,000 down payment. Scotiabank offers her a fixed mortgage rate of 4.5%. To qualify, Mandy must demonstrate she can afford a mortgage at 6.5%. Thus, while her monthly payment at 4.5% is $2,490, she must prove she can manage $3,014 at 6.5%.
If buyers fail to meet these qualifications, they risk not securing their mortgage, which can prevent them from closing the deal if they had already made an offer and deposit.
Appraisal Issues
Banks require home appraisals to determine a property’s market value before issuing a mortgage. In Ontario, buyers can only mortgage up to 80% of the appraised value of the home.
With recent declines in house prices, appraisals may come in lower than the agreed purchase price, creating a gap. Since banks won’t finance beyond the appraised value, buyers must cover this difference.
Example: Robert agreed to purchase a $1,000,000 new construction home in March 2022, with a closing date set for July 2024. By June 2024, when the appraisal was done, the market had declined, and the home was appraised at $800,000. The bank can only finance up to 80% of this value ($640,000), leaving Robert to cover the $360,000 difference himself.
This gap often makes it difficult for buyers to come up with the necessary funds in time, leading to failed transactions.
What Are the Consequences of Failing to Close a Real Estate Transaction?
If a real estate transaction falls through, both buyers and sellers can face significant repercussions.
Consequences for the Buyer
In Canada, the consequences for a buyer who fails to close are usually quite strict. The buyer typically loses their deposit and, in some cases, could be required to pay additional damages to the seller.
Deposit Forfeiture: Generally speaking, if a buyer breaches the contract, they forfeit their deposit to the seller, even if the seller doesn’t suffer any direct damages (Tang v Zhang). Even in rare cases where the seller is BETTER off by the buyer not closing. In this 2022 case, the court upheld the forfeiture of a $70,000 deposit despite the seller’s ability to resell the home at a higher price, highlighting the contractual nature of deposits.
Additional Damages: Buyers who withdraw from deals may also be liable for the difference between the original purchase price and any lower resale price, plus other incurred costs. The court may also consider any additional seller costs, like legal fees or moving expenses. A 2022 case illustrates this: the court awarded $906,474 in damages, including various carrying costs, after a buyer reneged on a deal.
Can I Use the Force Majeure Clause to Cancel My Deal? A force majeure clause can release a party from liability if unforeseen events make contract performance impossible. However, the courts have demonstrated that a downturn in the real estate market is not typically considered a force majeure event.
Consequences for the Seller
Sellers may also face repercussions if they back out of a deal. In some scenarios, sellers can legally withdraw from the contract, particularly if a contingency wasn’t met. In other cases, they may have to compensate the buyer, either through a lawsuit or by enforcing the sale.
Damages: Sellers might need to pay damages if they fail to close, including returning the buyer’s deposit, covering any fees the buyer incurred, or compensating for equity loss or price differences. In one case, a seller was ordered to pay over $11 million in damages for a failed deal.
Specific Performance: In rare cases, a court may order a seller to complete the transaction, particularly if the property is unique or if monetary compensation is inadequate.
Is the Real Estate Broker Entitled to Commission if the Deal Fails? Real estate brokers may still be entitled to commission even if the deal falls through, depending on the contract terms. For example, if the Buyer Representation Agreement states that the commission is payable regardless of the deal’s completion due to the buyer’s fault, the buyer must pay the commission.
Sellers might also owe the broker’s commission if they cannot close the deal. Always review the terms of all contracts carefully.
What Should I Do to Minimize My Losses?
Given the current economic conditions, both buyers AND sellers should take proactive steps to minimize potential losses.
Advice for Buyers
- Engage a lawyer early to review your Agreement of Purchase and Sale.
- Conduct thorough due diligence before signing. Ensure a comprehensive property search is done.
- Enhance your mortgage chances by improving your credit score, saving more for a down payment, and avoiding additional debt.
- Explore alternative financing if traditional mortgage approval fails.
- Consider a vendor take-back mortgage or seek financial assistance from family or friends.
- Obtain and verify property appraisals.
- Negotiate a mutual release with the seller if needed.
- Insert conditions into your purchase agreement to ensure financing, inspections, or other contingencies are met.
- Aim to complete the deal or negotiate an extension if possible.
- Take your time and seek legal advice to avoid rushed decisions.
- Document everything in writing.
Advice for Sellers
- Include conditions in the Agreement of Purchase and Sale to protect your interests.
- Take steps to minimize potential losses.
- Be flexible with the buyer if they face closing difficulties, such as offering an extended closing period in exchange for a non-refundable deposit.
- Consider a take-back mortgage or fair settlement to avoid costly litigation. If the matter ends up in court, it can take years before the issue is resolved.
- Hire a lawyer to navigate legal aspects and mitigate damages effectively.
- Document everything in writing.
Navigating real estate transactions can be complex and stressful, particularly when the potential exists for one party to not close. Engaging an experienced real estate lawyer can help ensure a smooth process and mitigate potential risks.
We are happy to provide you with a recommendation if you need one.
