What Is A Novation In Real Estate (And When Do You Need One?)

If you’re involved in a real estate transaction, a lot of things can change during the whole process. Between the first round of negotiations and the closing date, either party can ask for different terms.

A novation in real estate is when you replace an old contract with a new one due to term changes. Since you can’t just scratch out part of your contract and make the change, you need a legal method. Your real estate agent can help guide you through the process, and a real estate attorney reviews the final contract.

A home purchase is one of the most significant (if not the biggest) purchases you’ll ever make. Therefore, it’s essential to have all your ducks in a row when it comes to the necessary paperwork. The last thing you want is for your deal to fall through because of unclear terms.

In a short, novation is a legal term that describes switching one obligation or party to another. Instead of just adding to or altering an existing contract, a novation replaces the old agreement with a new legal agreement. A novation requires a valid former contract, a mutual agreement between all parties involved, and the termination of the original contract.

Novation can happen anywhere that valid contracts are formed from the financial market, to the buying and selling of a business, to real estate.

First, it’s important to understand that just because you need a novation doesn’t mean your real estate deal’s in jeopardy. Instead, it’s quite the contrary — a novation protects you from any confusion surrounding the contract.

When you put in an offer (or accept an offer) on a property, you need a written contract. Your real estate agent ensures that all of the buyer’s and seller’s terms are included in this agreement. Then, both the buyer and seller review the contract and sign it to seal the deal.

A real estate attorney reviews the signed contract to make sure everything is good to go. However, there’s often a long road to travel between signing that initial agreement and the final closing on the home.

And as the saying goes, anything can happen. Therefore, it’s not uncommon for either party to end up requesting changes before the finish line.

When this happens, the agent makes an entirely new agreement, which renders the former contract void. All involved parties look over and sign the new document. Then, a real estate attorney must once again review this newly signed contract.

Luckily, novations in residential transactions are somewhat easy to handle since it’s typically just between a buyer and a seller. In some instances, there could be a third party involved, such as a bank or mortgage company. Things can get a little more challenging in these situations, but a good agent can help move things along smoothly.

You need a novation anytime someone wants to change terms in the original contract, no matter how big or small. Additionally, verbal agreements don’t hold up in the long run. Even if both parties mutually agree to a change, it’s imperative that you have a written agreement.

Simply shaking on it without making a new written contract won’t be sufficient evidence or support for later disputes. Therefore, you must get a novation.

Here are a few examples of the most common situations that would require a novation in a real estate deal.

If you’re purchasing a new home, it’s wise to get a home inspection to ensure everything is in proper working order. Although sellers are supposed to fully disclose any issues with the property, sometimes things pop up. If the inspection reveals a major, costly problem, you might want to alter the original agreement.

Of course, several things depend on the wording in the original agreement. But, typically, you can make some choices when a home inspection goes awry.

For example, imagine the home inspection uncovers a significant problem, like mold. Obviously, you don’t want to move into a home with mold, but you might not be ready to walk away. Instead, you can request that the sellers fix the problem, pay for the problem, or you can kill the deal.

If you decide to ask for changes or for the sellers to pay for repairs, it’s time to renegotiate. You would then propose your request to the seller’s agent; if the seller accepts, the agent draws up a new contract.

This new agreement includes all of the new terms in detail. Then, you and the seller would review and sign the new agreement, voiding the old one.

In the example above, if the sellers don’t agree to fix the problem, they might lower the list price instead. A new price (no matter what the reason) makes it necessary to draw up a new contract. Once again, all parties review the changes, sign if they agree, and the deal moves forward.

Another example of a possible price change would be due to issues with the appraisal. If the appraisal comes back with a lower value than the list price, this can be a snag. Your lender might not be willing to lend you more than the home is worth.

However, depending on how eager the sellers are to sell, they might agree to lower the price. Therefore, you would need a new contract to lay out the new price and any new terms. Another possibility is that the sellers disagree with the appraisal and decide to pay for a new one.

If this happens, it could potentially push back your closing date, which is another reason for a novation. (More on this later).

Similar to a change in list price, if closing costs or other terms change, you will need a new contract. It doesn’t matter why or who makes the call, any variation from the original terms warrants a new written agreement.

The amount of the closing costs could change, or there could be a change in who pays for them. For example, after discovering issues in the home inspection, the seller might agree to cover the closing costs.

In this case, even though the amount of the closing costs is the same, you still need a new agreement.

Related Questions

What is the difference between novation and assignment in real estate?

Unlike a novation, an assignment does not replace the original contract. Instead, it transfers the rights and benefits of one party to someone else. The original party (the assignor) still carries the burden of the initial contract, but the benefits go to the assignee.In this situation, if the assignor fails to uphold their end of the contract, the assignee can hold them liable. The original contract is still valid and enforceable. In a novation, as discussed, a brand new agreement replaces the old one.

What is rescission in real estate?

When you rescind a real estate contract, you can back out of a deal for a variety of reasons. A rescission essentially puts you in the same place you were prior to signing a contract. You may want to rescind if you didn’t understand the terms upon signing, if you changed your mind afterwards. However, whether you are permitted to rescind a contract depends on the specific circumstances.

Are novations just a real estate thing?

Novations are commonly used in real estate, both for residential and commercial transactions. However, they are not solely for real estate deals. Novations are also necessary for business acquisitions, mergers, buy-outs, and other similar transactions. Basically, anytime the terms of a contract change, a novation becomes a probable reality.