Do You Know What Earnest Money Is and Why It's Important to Keep it Safe?
WHAT IS EARNEST MONEY?
When a buyer puts an offer in on a home and the seller accepts the offer, it is known as mutual acceptance. In the offer that is written, the contract indicates the amount of earnest money that will be put down.
Earnest money is usually between 1% and 5% of the home's purchase price.
Earnest money is a "good faith" deposit. For a $650,000 home, earnest money may range between $6,500 and $32,500. Buyers may try to make their bid seem more "serious" by offering more earnest money. When you put a higher earnest money number down on the offer, you are relaying to the seller that you are highly interested in the home and want to move forward with the purchase of the home.
The earnest money deposit is held in reserve, typically an escrow company.
Sometimes the money is held in a trust account at a real estate firm's trust account - but I don't have one for my brokerage - which is a conscious decision on my part. I prefer for the escrow companies to hold the money. After all, the money should be held with a neutral, third party or attorney that handles the exchange of money and documents once mutual acceptance is reached on an offer.
WHAT HAPPENS TO EARNEST MONEY?
If the sale is successful - it's easy. The earnest money is applied to your closing costs and down payment on the home purchase.
Where it gets complicated is if the deal falls through.
If the sale fails because of a failed contingency – the buyer typically gets the earnest money back without penalty (IF THE CONTRACT IS WRITTEN CORRECTLY).
Conditions included with an offer on a home that must be fulfilled before the deal can close. If a buyer or seller is unable to satisfy a contingency, then the offer on a home may become void.
Examples of contingencies are many - but the most common contingencies are financial contingency and inspection contingency.
Let's give a quick example.
A buyer purchases a home and needs a loan to purchase the property. It's the Seattle market place, and the home has had a pre-inspection. After a bit of deliberating, the buyer decides to waive the inspection contingency and put in the offer with the financial contingency only. The buyer puts $20,000 down in a check that is held in escrow.
Everything is going along very well, when the buyer loses his job. The buyer is no longer qualified to purchase the home and won't be able to re-establish employment in a timely manner for the close of the sale. After providing the proper paperwork from the lender and filling out the proper forms, the buyer terminates the contract due to failed financing and receives the earnest money back.
But - what if the buyer backs out of the sale for reasons not covered by a contingency? Then the seller keeps the buyer's earnest money. You see, earnest money is a good faith deposit. And if that good faith is ruptured, then the seller can remedy with liquidated damages. Those liquidated damages is the earnest money in escrow. And those liquidated damages cannot exceed 5% of the offer price, according to RCW 63.04.005.
Let's give another quick example.
A buyer puts an offer on a home, and gets mutual acceptance. The buyer puts $20,000 down and the check is held in escrow.
The buyer has a financial contingency only on the transaction. The buyer waived the inspection contingency.
The buyer gets cold feet and decides he doesn't want to help the lender and stops talking to his real estate agent and to the lender. The agent and lender continually try to contact the buyer, but there is complete radio silence from the buyer. The buyer decides to let the closing date come and go because he doesn't want to buy the home any longer. The buyer then reaches out to the agent and asks for their earnest money back.
Well - there are many things wrong with this example - but mostly - the buyer failed to, in good faith, continue on with the transaction.
In this case, the earnest money should go to the seller as liquidated damages.
I say "should" - because there's always going to be a fight. The escrow company won't just release money to one side or the other. Both sides must agree before any money is disbursed. Remember - escrow is a neutral, third party.
And if it cannot be agreed upon - well that's another story. It goes on to something called interpleader where a judge will make a decision and it gets very expensive for all involved. So, try and avoid that at all costs. Do the proper paperwork, write the contract correctly and communicate, communicate, communicate.
***TIP*** It's important to have a good real estate agent that knows how to fill out a contract properly, knows and understands the proper timelines for each addendum, and knows what to do if there is a hiccup in the transaction - and the proper paperwork they need to fill out to protect the earnest money.
***TIP*** It's just as important to know who the escrow company that is holding your earnest money as it is with the agent you choose and the lender that you will put your loan through.
Hello! I'm Kristin Bushnell, and I'm the Designated Broker for my firm, Bushnell Real Estate Solutions and Co-owner of Bushnell Craft Brewing Company in Redmond, WA. Check out my profile here.
If you are ever interested in chatting about real estate, contact me at firstname.lastname@example.org or call me at 425-559-1355. I'll buy you a beer (or non-alcoholic beverage, if you prefer!), and we can chat about real estate until your heart's content.