Think of an earnest money deposit as a security deposit. Once a home goes under contract, the seller will no longer seek other offers during the time the buyer needs in order to fulfill the contract. In exchange for not advertising their property for sale, the seller wants some security that the buyer will not break the contract. How does the seller get that security? Money!
Most often, the earnest money deposit is a check the buyer submits with their offer. It is only cashed when both buyer and seller have agreed to all terms of the offer, and everyone has signed the contract. The check is then cashed immediately by the buyer’s agent’s company and held in escrow until settlement. A buyer will get their earnest money deposit back at settlement, and the amount gets credited back to them…it usually goes towards the down payment or closing costs.
There is no standard amount for an earnest money deposit. Sometimes a seller will request a minimum amount, but in general, it is up to the buyer to decide. Since the check is cashed when the contract is ratified, the funds for the amount need to be liquid. In case the buyer needs a few days to pull money from different accounts, it can be written into the contract that the check will be held a specified number of days. As a guideline, realtors consider 1-3% of the sales price to be enough of an earnest money deposit.
The larger the earnest money deposit, the better a buyer looks to the seller. Sellers see it as less risk, and think that a large earnest money deposit means a buyer has the cash to obtain financing. In the days of multiple contracts, this was often a deciding factor when sellers had to choose between offers. In a market where property values decline as time goes on, it is especially important because a seller could ”lose” money if s/he has to put it back on at a lesser price if the contract fell through.
There is a risk of losing the earnest money deposit if a buyer breaks the contract, after removing certain contingencies. There are, what I call “Get Out of Jail Free” cards, which are opportunities for the buyer to legally get out of the contract with their earnest money deposit and no further obligation if done before the contract contingency time period expires. In the DC area, these are some of the typical contingencies:
- Home Inspection
- Appraisal
- Financing
- Condo or Home Owner’s Association document review period
I will talk more about these contingencies in a future blog, but you should always consult your realtor as laws often change and vary between jurisdictions.
If there is a dispute over the earnest money deposit, the company who holds it freezes the funds. Both seller and buyer need to come to an agreement about the dispersal of the earnest money deposit. The seller might give it all back to the buyer without qualm, or they might want it all and then some. It is a negotiation that should involve the realtors and their legal counsil. Don’t get too caught up on this, because buyers have those “get out of jail free cards” to protect them regarding the major issues of a home. Your realtor will also educate you about the contract and protect you from breaking a contract. Overall, this hasn’t been a problem for most real estate transactions.
If you have any questions about Earnest Money Deposits, let me know and I’m happy to answer them!
February 3, 2009 at 1:07 pm |
I have a question…if there is a dispute over an earnest money deposit, is the seller still ‘tied’ to that buyer until the dispute is settled? Or can the home still be sold to another buyer, just with the original EMD still in escrow?
This would be a huge help…and references to real estate law if they’re handy!
February 4, 2009 at 4:11 pm |
Hi Lacey,
This is a question for a real estate attorney because it involves breaking a contract. In the DC area, realtors must usually obtain a written release form signed by both the buyer and seller before we can put the home back on the market. If there is a dispute over the earnest money deposit, the buyer may not sign the release (which usually outlines how the EMD is to be distributed). Consult a real estate attorney.
April 1, 2009 at 3:35 pm |
If the buyer breaks the contract and loses the earnest money, where does it go? Does it go to the seller, the real estate agent, or the escrow company?
April 1, 2009 at 4:41 pm |
Hi Melissa,
Whenever you are talking about breaking a contract and taking money from another party, you’ll want to involve a real estate attorney in your jurisdiction. In the many real estate transactions that I’ve participated in, no one has breeched the contract and lost their earnest money deposit.
In the DC area, if the buyer cancels the contract outside of their contingency periods, the seller and buyer both need to sign a release that states what will happen to the earnest money deposit. It is a negotiation. The seller may elect to release the deposit back to the buyer. Conversely, the seller may want to take it all. If both buyer and seller cannot come to an agreement, it will most likely go to arbitration.
Once money is collected , however, the seller’s agent may be entitled to a portion of the earnest money deposit. Read the listing agreement for the terms.
July 15, 2009 at 6:45 am |
I am in the process of trying to purchase a pre-foreclosure in Alabama. I put in an offer on the home and they cashed my earnest money check 2.5 months ago. The home is still listed as active on the mls. The offer has a proposed closing date of July 31. I have not heard anything back from the sellers bank on acceptance/denial of the offer. I understand that the process of purchasing a pre-foreclosure can take weeks but I just want to ensure that the proper process is being followed.
If they accept the offer, do they have to give me more time to get inspection/financing being that the proposed closing date is now two weeks away?
Also, is there a limit on how long they can hold earnest money?
July 15, 2009 at 10:16 am |
Hi Chris,
I’m not sure what the custom is in Alabama. Here in the DC area, a pre-foreclosure is known as a “short sale.” As you already know, short sales are a long process (often taking months, not weeks, for a response) because the seller’s lender needs to approve your offer. It sounds like the seller approved your offer, and your agent deposited your earnest money check.
When I write an offer on a short sale, I write in the offer that the earnest money deposit will not be cashed until we receive the approval from the bank. Furthermore, I specify that all contingency dates start after the sellers deliver the third party approval (aka their lender’s approval) in writing. I don’t have my buyers spend money on anything (home inspection, appraisal, termite, etc.) until we get that third party approval. Oftentimes, the seller will approve the contract and the bank doesn’t. Then the buyer is out the money spent on those items.
In DC, there is no time limit for how long the earnest money deposit can be held, unless you wrote into the contract that if the sale doesn’t go through by a certain date, you would get a refund. Who is holding your earnest money deposit? Is it your agent’s company? If so, I’d ask them to return it to you until the offer is fully approved.
It looks like you need to re-read the contract to see what your rights are. Did your agent specify that your inspection dates started from seller’s approval or third party approval? If it is the latter, then you should be allowed time to conduct your inspections and push back settlement until you have removed those contingencies.
I think you ought to speak to your settlement attorney to ask for advice.
October 4, 2009 at 9:30 pm |
Hi
I was waiting on a short sale to be approved by a third party (Bank). The closing date on the contract has passed and due to my circumstances, I was no longer interested in the property. So i wanted to pull my contract, but when i contacted the agent he informed me that he had a verbal approval from the bank, i still asked him to pull the contract. Will i get my earnest money back since the closing date has passed and the bank approval documents for the sale documents have yet to arrive.
Thanks in Advance for the advice
October 5, 2009 at 7:55 am |
Hi M,
First of all, you can retract your offer at any time before your offer is accepted and a signed copy is delivered back to you. On many of the short sales offers I’ve submitted, the listing agent just sends the offer directly to the bank for approval, which does not make it a contract. But on occasion, the seller signs off on the offer before they send it to the bank for approval, which makes it a contract.
Second, your contingency has expired which should mean your contract is voidable. I can’t really get into it too much because each jurisdiction has different contracts and laws, and I don’t know yours. But I can say that in the DC area, we have a Third Party Approval contingency, and if the bank does not approve your offer within that time period, you automatically can void the contract.
Third, all contracts must be in writing in order to be enforceable (at least in our area). So a verbal agreement from the bank is not an enforceable contract.
Anytime you do not have a contract, or anytime you break your contract within your contingency periods, you should get 100% of your earnest money deposit back.
As always, consult a local real estate attorney to know your rights.
October 5, 2009 at 6:09 pm
Hi
Thanks for the reply , I had another concern,
my real estate agent is stalling for some reason, he has already taken 3 days and still hasn’t sent the notice to the selling agent to pull the contract, his reason is that he has been busy, should i be worried because in between this time the bank could send the approval for the short sale.