If you're currently looking to buy or sell a piece of real property, you probably have a lot on your mind. Real estate transfers are complicated affairs with multiple interested parties and way too many moving parts. Under these circumstances, it's easy to lose track of smaller things that could ultimately prove to be important. In states that allow it, the termination option is one such aspect of private land deals.
What Is a Termination Option?
The termination option is a clause that allows real estate buyers to back out of a purchase contract during a fixed period of time that precedes its official closing date. Designed to increase flexibility for buyers and sellers, the termination option allows both parties to court other suitors. It's also useful for buyers who wish to take a closer look at the terms of the purchase contract and the state of the parcel that they wish to purchase.
Typical Cost and Structure
The typical seller agrees to a termination option clause in exchange for a small fee from the buyer. This fee is usually calculated as a percentage of the total cost of the property and may increase in proportion to the length of the option period. Most termination clauses are worth less than $500 and last for no more than two weeks.
Structurally, they're quite simple: If a buyer who agrees to a termination clause backs out of the contract during the option period, the seller gets to keep his or her termination deposit. If the buyer doesn't exercise his or her termination option, the seller typically refunds the fee at closing. In most jurisdictions, the termination option is outlined in a specific section of the basic real estate transfer contract that binds private buyers and sellers. For instance, Texas's termination option comprises Paragraph 23 of the contract.
Rights of Buyers and Sellers
While the termination option is generally viewed as a buyer-friendly provision, it provides sellers with some rights as well. For starters, sellers may enter into informal "backup" agreements with other buyers during the termination period. Since termination option fees generally aren't held in escrow, sellers also enjoy immediate use of the money and don't have to worry about chasing down cold-footed buyers for payment at a later date.
For buyers, the termination option provides a window of time in which to perform various inspections, financial due diligence and other pre-closing tasks without losing the sale to a more eager buyer. At the same time, it also lets buyers shop around for other properties that may prove more desirable in the final estimation.
Benefits and Drawbacks
This clause is designed to reduce the frequency of lawsuits that arise after the unexpected termination of a real estate contract. Since these suits subject both parties to costs that far exceed the termination fee, this must be viewed as a win-win situation. By "freezing" the sale for a fixed period of time, the termination option also has the indirect effect of "cooling down" frothy real estate markets. This prevents land prices from appreciating too quickly within specific geographical areas. However, this may work against buyers and sellers who wish to expedite sales.
Termination Option vs. Earnest Money
Although it bears a superficial resemblance to the earnest money payments that most buyers issue in good faith, the termination option differs in some key ways. Termination fees are generally smaller than earnest money deposits and are usually refundable during the closing process. Whereas the termination option is designed to provide the buyer with pre-closing flexibility, earnest money has precisely the opposite effect. Unlike termination fees, earnest money payments are generally held in an escrow account that can't be touched by the seller until after the closing date.
Final Thoughts: Don't Sweat the Small Stuff
While many sellers are understandably wary of agreeing to accept the termination option as part of a real estate contract, its nominal size and short lifespan reduce its potential to cause hardship. In fact, many veteran sellers view the termination option as a key weapon in their arsenal of leverage tactics. In jurisdictions that permit its use, this seemingly inconsequential provision can work wonders for buyers and sellers alike.
