What is earnest money and how can you lose it?
Earnest money is an old term. Real estate purchase contracts used to be referred to as ‘earnest money’ contracts because the buyer would hand over a sum of money along with their agreement to demonstrate that they were earnest in their desire to purchase a property. This is still done today.
Though always negotiable, the amount of the earnest money deposit can vary greatly depending on the area and also the current market conditions. During times when the market is ‘hot’, sellers can demand higher earnest money amounts as they could get multiple offers on their property.
An offer with more earnest money supposedly demonstrates more sincerity in interest to buy, and therefore looks like a better option. When coming up with an earnest money amount, the challenge is deciding on a dollar amount that communicates your sincerity to the sellers, but is also an amount you could live without in a worse-case scenario.
From the buyer’s perspective, keeping the earnest money amount as small as possible is a good idea. Though it will be credited to the buyer at closing, it essentially boils down to having more money out of pocket now rather than later. Almost always, deals go through and the dollar amount is credited to the buyer at closing. But, in some instances, deals fall through. It is then that the issue of who gets to keep the earnest money can become problematic.
Once a contract is negotiated and agreed upon by both the buyer and the seller, the earnest money is placed in escrow with a neutral third party. At this time, the money is considered property of both the buyer and seller. If for some reason the transaction does not close, the earnest money does not automatically go to the seller. There are some cases where the money is refunded to the buyer.
For example, if during the inspection period, the buyer learns that something major is wrong with the house, they can terminate the contract and receive their earnest money back. In addition, even if the buyer is past the inspection period, but it is determined that they cannot obtain financing, their earnest money will generally be refunded if they are still within the window to obtain lender approval.
However, let’s say all has gone well and the buyer backs out at the last moment. In that case, they would forfeit their earnest money. Similarly, let’s say that the seller’s job transfer changes and they no longer wish to sell their home. In that case, the earnest money would definitely be due back to the buyer in addition to commissions that would be due both agents.
As you can see, this can get a bit tricky at times as sellers often feel they are due the money as repayment for having their house off the market to accommodate the buyer. In order to disperse the funds, the buyer and seller must come to an agreement. The third party will not release the funds without signatures of both parties. Because of this, coming up with a solution that is amenable to both parties is key.
Usually if the transaction falls apart early in the process, it isn’t a problem and the seller is glad to refund the money. Failure to reach an agreement just ties up the money and makes it unavailable to both parties. Though this may seem challenging, a seasoned real estate pro will know how to handle this type of scenario. In the end, if both parties can agree to what is fair, it is not a problem, and in some cases, splitting it could be the best option.
With thanks to Kimberley Kelly for contributing to this article. She is a Realtor who helps home buyers find Indian Wells homes and Indio real estate in the southern California Desert.