Before your buyers write that earnest money check, find out the purpose of an Earnest Money Deposit (EMD), how to avoid costly mistakes on the home purchase, and ways to lose earnest money.

They’ve found the home of their dreams and you’re working with your buyers to put together a winning offer. Part of that involves writing a fairly hefty check for the Earnest Money Deposit or EMD. You may take the EMD for granted as just part of the process -- until a deal falls through, you're losing earnest money, and those thousands of dollars are in jeopardy. The unexpected can happen prior to closing so it’s vital to explain to your buyers what’s at stake, ensuring that they are not blindsided by the loss of an Earnest Money Deposit.

How can you lose your earnest money deposit? Whether it involves a change of heart or a change in circumstances, here are ten scenarios where you can lose earnest money deposits-- and ways to protect your clients.

1. Failing to Meet Deadlines

When your buyers sign a purchase contract, they also agree to a timeline for home inspections, contingencies, and closing. If these major milestones along the road to the closing table don’t happen, the transaction could be put into jeopardy -- and that would be the buyer’s fault. If they are unable to fulfill the terms of the contract, the sellers would be justified in working to find another buyer -- and keeping the EMD. Make sure you are keeping your buyers moving forward with effective transaction coordination so that they are able to meet their contractual obligations on time.

2. Getting Caught Up In a Bidding War

We’ve all experienced low-inventory markets with multiple offers and bidding wars on every new home that comes on the MLS. In that kind of heated atmosphere, buyers can get scared and desperate -- causing them to jump the gun and offer on anything that becomes available. In addition, they may include higher than normal EMD’s to sweeten their offer. If they then realize the house is not for them, they could find themselves losing thousands when they back out of the contract. Make sure you help clients stay steady in the midst of a high-pressure market so that they can avoid this type of mistake.

3. Agreeing to a Non-Refundable Earnest Money Deposit

In some purchase scenarios, especially those involving bank-owned properties or investment properties, a non-refundable EMD may be required in order to show that the buyers are serious about seeing the transaction through. If your clients are confident that their financing and other contract requirements are on track, this may be worth it to them. However, make sure that they have a clear understanding of this part of the contract before they sign that earnest money check and sign away their rights to a earnest money deposit refund.

4. Waiving Contingencies Prematurely

When you are putting together an offer in a multiple offer situation, you may be nervous about asking for too much from the sellers. In that case, you may add fewer contingencies to the sales contract. Alternatively, once you’re under contract, you may mistakenly assume that some of its requirements have been fulfilled and release those contingencies prematurely. In either case, a lack of adequate contingency protection can lead to a cancelled contract or a cancelled earnest money check-- and a lost EMD.

5. Failing to Do Due Diligence

If your client is an investor or just a bargain-hunter, he or she may find a great deal and be eager to act on it, going under contract without a home inspection or other due diligence. In fact, part of the value-add many investors offer is an inspection-free process and fast closing. If the client then finds out that the home has some costly problems, he or she may need to sacrifice that EMD in order to get out of the contract.

6. Failing to Understand “As-Is” Buying

Many ask "when does a buys lost earnest money?" Well, some buyers are eager to take advantage of the money-saving opportunities offered by an As-Is property, assuming that they are handy enough to tackle a fixer-upper. However, major structural damage, termite damage, or other systems failure could result in more than they bargained for. In this case, it is important to have a home inspection contingency with the stipulation that no repairs will be requested. Otherwise, your buyers could find themselves losing their earnest money deposit to back out of the contract.

7. Voiding a Contract Without a Refund

In the case of a mutual decision to void a sales contract, it is important that the full earnest money refund is stipulated clearly in order to ensure that the seller isn’t planning to keep some or all of it. Once the contract is void, the buyer has given up any possible leverage they would have in order to compel the seller to release their deposit.

8. Deciding the Home Isn’t “The One”

Do you get earnest money back? Do you lose earnest money if you back out? For many people, buying a home is a very personal and emotional decision. For this reason, some buyers may decide on second or third viewing that the home just isn’t the right one for them. Since there is no contingency for a change of heart, it is important that buyers know that canceling the contract without cause may result in the loss of the EMD.

9. Developing FOMO Over Another Home

Just like falling in love, some buyers may enjoy the pursuit more than the capture -- falling in love with one home until they go under contract, then worrying that the right one is still out there somewhere. Here too, this emotion-based reason for canceling a contract will generally be punished with the loss of the EMD -- in part because of the loss in value anticipated by the sellers when they have to put their home back on the market.

Bailing on a Transaction for Personal Reasons

Finally, a big reason that contracts fall through -- other than home condition or financing issues -- stems from personal issues on the buyer side. An illness, a broken engagement, an unforeseen divorce, a job loss or change -- any of these can result in a fundamental shift in planning for the buyer and a genuine inability to see the contract through to closing. In these cases, the sellers are justified in keeping the EMD. In cases of hardship, you may make an appeal on the buyer’s behalf, however the sellers are under no obligation to return the deposit.

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About the Author

Evan is part of the Business Development team at Endpoint. He is focused on growing the Southern California market and brings with him extensive experience in growing technology solutions.

Introduction

Disputes over earnest money usually arise when either buyer or seller perceives the other to be at fault for failing to close in a timely manner. The parties can be emotional, unreasonable, and determined to stand on principle, all common shortcomings in persons who may threaten to file lawsuits but are unacquainted with the costs and burdens of litigation. Usually &#;fault&#; is not the issue, at least as to earnest money, since its orderly disposition is expressly governed by the TREC contract and its addenda. Problems and the potential for litigation most often arise when a party refuses to do what the contract says.

This article does not address what occurs when earnest money is not deposited at all, except to observe that this constitutes a breach (a default) by the buyer in the case of an otherwise valid and accepted earnest money contract. Failure of the buyer to perform in this regard does not, as many believe, cause the contract to fail altogether.

Buyer Withdrawal Because of Failure to Obtain Financing

A common area of dispute is the buyer&#;s inability to obtain financing. Note that the TREC Third Party Financing Addendum contains a blank for a specific time during which the buyer must notify the seller of his inability to obtain financing. If this notice is not timely given, the contingency is waived. Buyers often miss this detail and insist on their continuing right to get their earnest money back if their loan application is denied, even after the specified time has run.

Sellers, on the other hand, may believe that the buyer did not make &#;every reasonable effort to obtain credit approval&#; (as required by the TREC addendum) and therefore should not be entitled to return of earnest money even if notice is given within the prescribed period. Unfortunately for this point of view, the addendum does not go into detail about what &#;every reasonable effort&#; means.

Contract Provisions Relating to Release of Earnest Money

Whatever the cause of the dispute, paragraphs C through E address the procedure for release of earnest money:

C. DEMAND: Upon termination of this contract, either party or the escrow agent may send a release of earnest money to each party and the parties shall execute counterparts of the release and deliver same to the escrow agent. If either party fails to execute the release, either party may make a written demand to the escrow agent for the earnest money. If only one party makes written demand for the earnest money, escrow agent shall promptly provide a copy of the demand to the other party. If escrow agent does not receive written objection to the demand from the other party within 15 days, escrow agent may disburse the earnest money to the party making demand reduced by the amount of unpaid expenses incurred on behalf of the party receiving the earnest money and escrow agent may pay the same to the creditors. If escrow agent complies with the provisions of this paragraph, each party hereby releases escrow agent from all adverse claims related to the disbursal of the earnest money.

D. DAMAGES: Any party who wrongfully fails or refuses to sign a release acceptable to the escrow agent within 7 days of receipt of the request will be liable to the other party for liquidated damages in an amount equal to the sum of: (i) damages; (ii) the earnest money; (iii) reasonable attorney&#;s fees; and (iv) all costs of suit.

E. NOTICES: Escrow agent&#;s notices will be effective when sent in compliance with Paragraph Notice of objection to the demand will be deemed effective upon receipt by escrow agent.

The contract is clear. Upon failure of the contract for any reason, the party desiring the earnest money must make written demand upon the title company. A copy of the demand should be sent to the other party. The written demand triggers a day window during which the other party may make written objection to the title company. Phone calls, almost always legally insufficient in real estate for notice purposes, will not meet the requirements of the contract. Fax? Maybe. Email or text might be sufficient, since Texas is gradually recognizing the legitimacy of these forms of communication, but certified mail to both the title company and the other party is always best, particularly if litigation is a possibility. There is nothing like being able to show a signed green card to a judge in order to prove that notice was given. Send another copy by first class mail.

The language of the contract is vague about which demand—demand from the party desiring the earnest money versus demand from the title company—triggers the and 7-day periods, but it is prudent to be conservative and assume that these periods begin when the first party makes written demand.

What happens next?

The title company will follow up with a notice of its own that written demand has been made and enclosing a release form for signature. It must be signed by all parties and their brokers. Fifteen days are allowed for written objections to be made.

The TREC contract formerly made the choice of mediation elective in paragraph There is no longer a &#;yes or no&#; box to check on the latest form of this contract, so mediation is now required as a means of settling disputes—unless this paragraph is either struck and initialed or a special provisions addendum is attached that deals differently with dispute resolution. Generally, including a mediation requirement is a favorable provision for the seller, less so for the buyer.

Lawsuit Remedy in Justice Court

Lawsuits may be filed in justice court so long as the total amount claimed (including attorney&#;s fees) does not exceed $10, If total damages exceed that amount, then suit may be filed in the county court at law. Named defendants should include the party refusing to sign the release and the title company holding the earnest money. Title companies will usually respond by interpleading the earnest money (depositing it into the court&#;s account) which removes them from the merits of the litigation. The title company may then seek dismissal from the case or decide to remain in an attempt to recover attorney&#;s fees from the party at fault.

Before filing a legal action concerning earnest money, it is useful to consider the practical reality that attorney&#;s fees and costs, once added up, can easily exceed the amount of earnest money in dispute. As a consequence, many earnest money disputes are resolved by the parties&#; splitting the funds and going their separate ways, respective claims of principle notwithstanding.

Can you avoid earnest money disputes by imposing a liquidated damages penalty?

The idea here is that the contract would contain a liquidated damages clause to be applied in the event the seller refused to release the earnest money, something sufficiently harsh to discourage a seller from withholding these funds. A clause such as this would have to be included in a special provisions addendum. In Magill v. Watson, S.W.3d (www.oldyorkcellars.com—Houston [1st Dist.] , no pet.), the court disallowed such an arbitrary treble-damages penalty because it was not rationally related to any actual damages that the buyer would suffer. It left open, however, the possibility that such a clause would be enforceable if the provision reflected a reasonable assessment of what the buyer&#;s damages would be.

DISCLAIMER

Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well since we are not tax practitioners and do not offer tax advice. This firm does not represent you (i.e., no attorney-client relationship is established) unless and until it is retained and expressly agrees in writing to do so.

Copyright © by David J. Willis. All rights reserved. Mr. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.oldyorkcellars.com

What is an earnest money deposit? How does an EMD differ from a down payment? Where does an earnest money deposit go and why is it important? 

Both earnest money deposits and down payments are critical parts of the home buying process, but they are definitely not the same thing. However, in both cases, the more money you can offer, the better your chances may be of getting the home you want. So, what is the difference? Let’s discuss.

Let's go into depth about the terminology before we continue! 

To read more about this topic, check out these blogs:

What is an EMD? 

To show a seller that an offer is serious and made in good faith, a prospective homebuyer will include a check with their offer, for typically % of the purchase price. This is known as the “earnest money deposit” and is an integral part of a buyer’s offer. The seller may get to keep that money if the buyer pulls out of the deal for a reason that isn’t allowed under the purchase contract, such as the buyer simply changing their mind after the contract is ratified. A strong earnest money deposit essentially acts as security and incentives the seller to accept an offer and take the home off the market versus waiting for offers from additional prospective buyers.

If the seller has several offers, a larger earnest money deposit could set you apart from the competition. For more expensive properties, your real estate agent might be able to negotiate a lower deposit. As a general rule, earnest money is worth as little as a seller is willing to accept and as much as a buyer is willing to offer.

 Always make sure you have the money in the bank before you submit a check with your offer. The earnest money deposit is typically turned over to the title company after the contract is ratified and they will cash it shortly thereafter. The money is placed in an escrow account until closing. If the deal goes as planned, the earnest money is usually applied towards your down payment. In the event you negate the contract due to one of the contingencies in your offer, such as the results of the home inspection, your earnest money deposit will usually be returned. Make sure you read your refund agreements carefully.

What is a down payment?

The down payment is the amount of money that the lender requires you to put towards the purchase of the property. Normally based on a percentage of the total sales price, the amount is typically established early in the loan application process with your lender. While down payment amounts can vary from percent for an FHA loan to upwards of 20 percent for certain conventional loans, normally the source of the money must be verified and approved by the lender. (For more information on this, we recommend reaching out to marketing@www.oldyorkcellars.com and we can put you in contact with our preferred home mortgage companies) 

With a higher down payment, your chances of getting approved for a mortgage are higher. In addition, you will have a smaller monthly mortgage payment and more equity in your new home.

What are three scenarios in which you could end up losing your deposit to the seller? 

1. You Waived Your Contingencies

In highly competitive markets, it’s becoming more common for buyers to waive contract contingencies regarding financing or an inspection. You might be tempted to do the same if you’re really after a particular property. It will make you a more attractive buyer, but it also comes with serious risks. You guessed it, you might lose your earnest money deposit.

The financing contingency guarantees that you will get your money back if the financing is not approved. With the inspection contingency, you can declare the contract null and void (and get your deposit returned) if there are issues uncovered in the home inspection that make you change your mind about purchasing the home.

If you waive all your contingencies and there are financing or home defect issues, you will not be able to get your deposit back if you abandon the deal. Therefore, you may not want to waive the inspection contingency unless you’re planning on tearing the property down. Or, if you think you will be in a competitive offer situation, you could do an inspection before submitting an offer. That way you know ahead of time if there are any serious issues with the home that would prevent you from purchasing it, and can submit an offer with the home inspection contingency waived. As for the financing contingency, waiving it may be the only way to compete with all-cash buyers. However, you have to be absolutely sure that you’ll be able to get approval from the bank.

2. You Ignored the Timeline Outlined in the Contract

Your contract usually sets specific time frames in which you need to secure financing and do any inspections. If you try to void the contract after any of these deadlines have passed, you could lose your deposit. Generally speaking, as long as you’ve made a good-faith effort to adhere to the timeline, sellers will grant a reasonable extension if the lender needs more time or there are other extenuating circumstances that delay things. Any extension must be made in writing and signed off by both the seller and the buyer.

3. You Get Cold Feet

If you have a change of heart about the home you’re buying, but there’s no problem with the property or the financing, you likely will not get your deposit back. The earnest money deposit serves as protection for the sellers when they take their home off the market. If late in the game you decide that you no longer want to make the purchase, they get to keep it as compensation for the time and money they have to spend on listing their home again and looking for another buyer.

However, if you do change your mind, you may not be limited to losing the deposit only. The sellers could sue you for specific performance and all the tertiary costs that go with that, including their legal fees. For instance, let's say the sellers moved out of the house and that they staged the home by bringing in additional furniture. When the house goes under contract, they move the furniture out so that they don’t incur further staging costs. If the buyer backs out due to cold feet, think of the additional costs that the seller now bears, which could be more than the cost of the deposit. You could be responsible for these costs as well, so be careful.

In Eric Stewart's Words:

"From personal experience, I have a fourth scenario in which buyers could lose their deposit. This is if they don’t represent their financial situation truthfully. Last year, buyers who ratified a contract on a listing I had committed fraud. They represented their ability to purchase the home based on income and assets that were not real. They put up a $25, deposit on a $, purchase in McLean. We went after that $25, and got % of it for the seller. The seller ended up putting the property back on the market and actually came out slightly ahead because of the deposit, but nobody wants to go through the pain and aggravation of all that, right? Of course not. When you're a buyer and making an offer, make sure you represent yourself honestly."

*DISCLAIMER: Each jurisdiction has different terminology in their contracts on how the EMD should be distributed in the event of being forfeited by one of the parties of the contract. It is always important to consult with your REALTOR® or seek legal advice by a qualified attorney.*

Listen to Pointing You Home and Real Estate NOW on WMAL for more information about this and much, much more. Find Real Estate NOW on Spotify, iHeartRadio, and your other favorite podcast platforms. 

Earnest money is an initial payment that a homebuyer offers to a seller in order to sign a purchase agreement letter. Earnest money deposits are fairly common in competitive markets, especially when a seller is concerned that a buyer may make multiple offers on numerous properties.

It may possible to buy a home without putting down earnest money, but it is uncommon, and it is rare that a seller will waive an earnest money deposit.

As soon as an agent or broker accepts an earnest money deposit on behalf of a seller, they become an escrow agent, and the money is placed in an escrow account.

In most cases, when it enters into escrow, the earnest money cannot be released until both parties provide written permission. If a deal falls apart because the home doesn't pass inspection or doesn't appraise high enough, the earnest money will most likely be returned.

Earnest Money Deposits

The rules that govern earnest money deposits in real estate transactions vary from state to state. It is common for prospective buyers to set down earnest money equal to 1 to 5% of the purchase price of the home. For example, if you are buying a $, home, you may end up making an earnest money deposit for as much as $20,, just to show the seller you are a serious buyer.

In most cases, the earnest money, once released, is applied as part of the down payment or used to pay closing costs.

Potential homebuyers are discouraged from giving earnest money in cash directly to a seller, for multiple reasons, namely, it may be harder to get your money back if the deal falls apart.

The Release of Earnest Money

There are very few universal rules when it comes to handling earnest money. Instead, the rules are established in the sales and purchase agreement of the home. The agreement covers how refunds are handled—if there is a cancellation fee if the buyer backs out and under what parameters the broker or title company determines if the money is returned.

It is always a good idea for the broker to seek a written release from both parties before releasing the earnest money deposit. If both parties claim the deposit, the broker should not release the funds until the two sides have come to terms or a court order is presented.