Tuesday, November 8, 2022 / by Teresa Dipeso
Earnest Money: What You Need To Know
The earnest money deposit is included with a real estate purchase contract to reassure the seller that a buyer is “earnest” and making a good-faith offer to purchase a house. But what if the buyer just feels remorse, wants to renegotiate, or has the financials fall through? Can the buyer get the earnest money deposit back for any reason? Or will the deposit be forfeited so the seller is fairly compensated for the time the real estate property was off the market?
Here’s everything a home seller needs to know about earnest money, and how to keep the funds if possible when a sale goes south.
Determine how much earnest money is enough
The amount of an earnest money deposit can vary wildly.
This makes determining the actual figure of an earnest money deposit that works for both buyer and seller a negotiation within the overall negotiation of the sale. While buyers will generally want to part with as little earnest money as possible to limit their potential loss, a real estate seller needs to ensure the earnest money reflects the buyer’s commitment to close on the property.
Earnest money is typically between 1% and 2% of the real estate purchase price, but it can go as high as 10%. Since the money will serve as monetary damage if the buyer breaches the contract and fails to close, the seller must also carefully consider what amount would adequately compensate for the lost time in selling the home.
Be reasonable—too high an earnest money requirement could scare away potential buyers.
Consider cashing the earnest money deposit
Often an earnest money deposit is a check held by a seller’s real estate brokerage in good faith, but it’s not cashed.
Granted, the earnest money will remain in escrow until the real estate deal either closes or falls apart. If the latter happens, having cashed the check and placed the amount in escrow will prevent the buyer from cleaning the money out of the account the earnest money check is written from, causing the check to bounce.
Know who is holding the earnest money deposit
The earnest money may be held by the seller’s real estate broker, but the money may also be held in escrow by a third-party title company, lawyer, or bank. The purchase and sale contract specifies where the deposit is held.
When the sale closes, the earnest money is applied with the down payment and other funds during escrow to purchase the house.
Understand your contingencies
Contract contingencies provide myriad ways for a buyer to legally back out of a sale. A seller needs to scrutinize and minimize every buyer “back door” addendum and close any that they can, says Davis.
That means if a buyer simply gets cold feet, he can’t use a contingency as a way to worm out of a contract. If you’re selling in a hot market, you might even ask the buyer to waive certain contingencies.
Typical contingencies include the following:
- Financing: A buyer gets his earnest money back if his mortgage falls through. He must show that he attempted to get financing, however, or forfeit his money.
- Condition: If undisclosed problems with the property are discovered by a home inspection, the buyer can generally back out with no earnest money penalty. Not all items found by a home inspection are grounds for getting out of a transaction. For example, a leaky roof is a good reason to back out of the sale. A home inspection that finds cosmetic items or normal wear and tear, however, should not be cause for ending the contract.
- Title search: A buyer can usually void a contract and get the earnest money back if a title search comes back with a lien or issues with the ownership of a property. To avoid this circumstance, sellers can do a title search before listing to clear up any red flags.
- Appraisal: When a property appraisal is less than the sale price, a buyer can renegotiate or walk away from the transaction and the deposit is contractually refundable. If the buyer still wants the house, he may have to make a larger down payment to qualify for a mortgage. A seller should work with a real estate agent to price the home appropriately and avoid this scenario.
Remember, if the contingencies in a sales contract are fulfilled and the buyer still doesn’t close, the seller is entitled to keep the buyer’s earnest money.
Keep an eye on contingency time frames
With every real estate contract, contingencies must be met by the buyer and the seller within specific time frames.
If one party fails to complete the required action within that time frame, that party has defaulted, according to the contract. For instance, a buyer might have 17 days to complete an inspection. If the buyer fails to do so, the seller may be able to keep the earnest money. (Just keep in mind that this cuts both ways—so the seller should pay special attention to the time limits, too.)
A seller can also add a “time is of the essence” clause into the purchase agreement. This means the closing date for the sale is binding. If the buyer can’t close for any reason, the contract is breached and the seller can keep the earnest money deposit.