I just read your original post again. If you hired a professional home inspector per your real estate purchase agreement, and he/she found water damage (that you already said you want no part of), and has documented that in his/her written report, this transaction is done. Absolutely no way you should proceed with the purchase.
In my opinion, you should in writing notify the broker holding your deposit in their escrow account along with a copy of the inspection report, that you are NOT proceeding with the sale, and you want your good faith deposit returned with x number if days. When that time frame expires, if you have not received your funds back, seek out and consult with an independent attorney specializing in real estate law.
This should be a cut and dried situation detailed in your purchase agreement. IMO, the broker and agent(s) know this. Good luck to you and husband, and keep in mind there will be other properties for sale in the future.

Perhaps not, but wouldn't the current owner have noticed a wet closet floor? Why buy a home with unresolved issues when the purchaser has so much on her plate now and a short time until closing? It doesn't make sense to me to risk that much when it's not necessary.

Yes, but…
My agent recommended the home inspector who I found out later, even though I would have paid, was working for her, not me. I used D’Angelo who worked for me. I knew I was working with someone unethical (agent), but I used to be in real estate myself for a short while.

I would normally avoid a lawyer like the plague, but not in this case. The broker is licensed by the state and must follow the state's laws of ethics. That means that they have a fiduciary duty to both the buyer and the seller, even if they don't legally represent them. This broker knows that the buyer doesn't want to buy the house, that there is good reason to be concerned about future mold or other consequences related to a water leak, and that the buyer's husband has a serious illness. Yet, the broker is misrepresenting the status of the earnest money that is in escrow so that they can unload an unwanted house to get a commission. The broker cannot legally take the earnest money, but they are telling the buyer that they can as a scare tactic. Outrageous. The OP needs an attorney.

The repair was done by neighbor why should seller be responsible for neighbor that damaged his house?

Well, your advice is invariably great. I defer.

Agree completely. Simply get the home inspector to go back. The inspector will not lie or coverup a problem that has not been repaired to standards.. He is a licensed professional. Home will not close until the buyer is satisfied with the final walkthrough. The Agent is just wasting time for no reason. Home inspector is the right solution.

How do you know an attorney will cost a fortune? Moreover, what will cost more, an attorney or repairing a potential water issue in a house? What will cost more, an attorney or the cost of a failing house? How much does the house cost? How much does an attorney cost? Have you consulted any lawyer about his or her pricing?

To me it sounds like you just have never dealt with an attorney and know nothing about the pricing of an attorney's services!

That check shouldn’t be cashed till closing day IMO. Otherwise IMO it’s stealing.

Hook Set
 

The hook is set, the real estate agent and the seller who hired him in no way wants you to get off the line. This sounds like a very dangerous situation financially.

No idea why the owner didn’t notice. But why buy the home? Because they signed a contract to buy the home and allowing for repairs of inspection issues. Imagine you are the seller. A new issue arises just before inspection. You didn’t know about it and you are moving to a home you purchased. You need to sell your home to buy your new home. Everything seems fine but then there is a repair needed. You make the repair and fulfill your obligation under the purchase ageeement. Then the buyer gets cold feet and backs out. You did everything right and now you are screwed.

I’m sorry but people need to understand their contract and follow them. There are 2 sides to every story. In this case the buyer should be provided proof of repair and the. They should buy the house as agreed. Of course if the seller won’t supply documentation of repair then I’m on the buyer’s side.

I seem to have missed that part. But the seller does have to show that it was repaired properly. I’m sure the neighbor would provide that info.

By hook is set you mean the purchase and sale agreement is signed. By not wanting to let them off the line you mean not want the buyer to break a contract they signed. By the way the seller could be on the hook for their deposit on another purchase if their buyer backs out.

That is why the buyer needs to hire her own home inspector to make sure that everything is fine and then they go ahead. If everything is fine ACCORDING TO HER OWN INSPECTOR, then she should go ahead with the contract. I would never trust an inspector suggested by the seller or agent, I don’t care what certification they have.

What about the escrow company? In a typical real estate sales contract, the earnest money is held by a third party in an escrow account that does not belong to either the buyer or the seller. The earnest money is rarely ever forfeited because the purpose of it is to demonstrate that the buyer is serious about buying the house, not to be used as a threat or penalty against the buyer to force a sale. But, the broker has told the buyer that they will automatically forfeit the money if they don't complete the sale. Totally not true. What is wrong with the buyer asking an attorney to review the contract, explain their rights, and ask the escrow company to refund the earnest money? The escrow company is the decider here, not the broker. It sounds like this broker has not treated the buyer ethically or in a fair and fiduciary manner, as required by law.