Wouldn’t it be nice if every real estate transaction closed without a hitch? The reality is, obstacles can sometimes pop up during the closing process and, to protect the seller, most real estate contracts will require potential buyers to put earnest money in an escrow account. But what is earnest money, who handles the escrow account, and what happens to your money if you decide not to buy?
What is earnest money?
When buying a home, the buyer is usually asked to put down a certain sum of money to show the seller that you’re serious about buying their home. This may also be referred to as a good faith deposit. The amount you put down will depend on the purchase price of the home you’re looking to buy and the housing market in that area. Typically, the earnest money will total about 1% to 5% of the cost of the home you’re hoping to buy. This money is not paid directly to the seller. Instead, it is placed in an escrow account.
What is an escrow account?
An escrow account, according to Bankrate, is “a legal arrangement with a neutral third party, where money is deposited per the terms of a contract.” Depending on where you live, a real estate agent or a title company will act as the escrow agent (i.e. neutral third party). Your earnest money will stay in the escrow account until the home purchase transaction is complete or terminated.
While it is typically up to the buyer to pick the escrow agent, the seller must agree. Your REALTOR® can help you find a reputable and trustworthy agent. MYMOVE™ suggests buyers, “check the credentials of any potential escrow agent, and in no circ*mstances should a buyer give earnest money directly to a seller.”
What does an escrow agent do?
When it comes to closings, an escrow agent serves as a neutral third party and is responsible for a variety of tasks including:
- Performing a title search
- Requesting a statement from the seller listing all debt the buyer will take on with the purchase.
- Ensuring the contingencies listed in the contract are met.
- Preparing and recording the deed and other documents related to the escrow.
- Closing the escrow account and dispersing the funds.
What if I decide not to buy, will I get my earnest money back?
It depends on why you are backing out of the deal. There are certain contingencies covered in most real estate contracts protecting the buyer. If you back out of the contract for an approved contingency, you will get your earnest money back.
You can expect your earnest money back if:
- The home doesn’t pass inspection.
- The home appraises below its sale price.
- You are unable to obtain a mortgage.
- The home has title search issues.
You might not get your earnest money back if:
- You don’t meet the deadlines listed in the contract for inspections and appraisals.
- You have a change of heart.
What if the seller doesn’t agree to give me my earnest money back?
REALTOR® Magazine urges homebuyers to confirm that the home purchase contract describes the duties of your escrow agent because “When the parties cannot come to an agreement as to the release of escrow, and they make conflicting demands for the funds, the escrow agent will generally not be able to release the funds to either party.”
Furthermore, the article suggests contacting your escrow agent immediately if the seller attempts to make a claim on the escrow funds that you don’t agree with. Letting your agent know promptly of the dispute will help stop the funds from being disbursed. You can, and in some states you are required to, enter into mediation or arbitration before taking legal action when escrow funds are in debate.
If the dispute cannot be settled through mediation, your escrow agent will file an interpleader action to be removed from the dispute and your funds will be deposited in the registry of a court. The escrow agent will receive reimbursem*nt for attorney’s fees that are accrued during the filing of the interpleader action. This reduces the amount of your earnest money fund which is why, according to REALTOR Magazine “purchase contracts – and common sense – dictate that buyers and sellers should try to come to an amicable settlement to avoid the cost and other challenges of litigation.”
In most cases, if you decide not to buy a home you have put earnest money down on, you can expect to get that money back. Occasionally, even if you back out of the deal for a reason not listed on the contract (say the location of your job changes), sellers in a competitive market will release your earnest money back to you knowing another deal is just around the corner. Nevertheless, it’s always smart to review the contract, speak with your REALTOR®, and enlist an escrow agent to make sure you don’t lose your earnest money if you do have to back out of a deal.
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FAQs
The earnest money can be held in escrow during the contract period by a title company, lawyer, bank, or broker—whatever is specified in the contract. Most U.S. jurisdictions require that when a buyer timely and properly drops out of a contract, the money be returned within a brief period of time, say, 48 hours.
Who keeps earnest money if deal falls through? ›
If the buyer decides to cancel the sale without a valid reason or doesn't stick to an agreed timeline, the seller gets to keep the money. These are the most common ways a buyer will lose their earnest money.
What will most likely happen to the earnest money if the seller breaches the contract? ›
If the Seller can show they acted in good faith and you cannot prove you were financially affected, you may only be entitled to your earnest money deposit, along with interest and reasonable expenses, such as the cost of a survey, title examination, and attorney fees.
What happens to earnest money if offer is rejected? ›
It's held in escrow as a show of good faith that you're interested in purchasing the home. If your bid wins, your earnest money is deducted from the amount you owe at closing. If the seller rejects your offer, your earnest money should be returned.
Do you lose earnest money if you back out? ›
Backing out without a contingency
If you don't have a contingency to protect you if that happens, you'll most likely lose your earnest money deposit and, in some cases, be subject to other penalties, however. If you back out for any reason and are not covered by a contingency, you'll most likely lose your deposit.
Why would you lose earnest money? ›
These contingencies include failure of a home inspection, failure to secure financing, or failure to sell a separate existing property. If the buyer decides to not proceed with the sale for reasons outside of these agreed to contingencies, the buyer is at risk of losing earnest money.
What happens to earnest money if seller defaults? ›
Seller defaults: The buyer gets the earnest money back if the seller can't complete the sale. Mutual agreement: If both parties agree to cancel the contract, the buyer will usually get back the deposit. If the agreement relates to a buyer default, the buyer and seller may split the deposit by agreement as well.
How common is it to lose earnest money? ›
The earnest money pledged with an offer can be a vital tool (among many others) that a skilled agent can use to strengthen a buyer's offer. However, the EMD is both a tool and a risk to the buyer. Although buyers losing their earnest money deposit is relatively rare in our market, it can and does happen.
What are the 3 consequences of a breach of contract? ›
These include damages to compensate the business for their financial losses, specific performance to ensure that the obligations are still performed, or termination of the contract to end the commercial relationship altogether.
What can buyer do if seller fails to complete? ›
And in many cases, a home seller who reneges on a purchase contract can be sued for breach of contract. A judge could order the seller to sign over a deed and complete the sale anyway. “The buyer could sue for damages, but usually, they sue for the property,” Schorr says.
A seller that feels entitled to the deposit or a buyer that feels a refund is deserved will try to get escrow to release the deposit. Escrow cannot release the deposit without instructions signed by both the buyer and seller or a court order from one of the parties.
How do I not lose my earnest money? ›
How to protect your earnest money deposit
- Put everything in writing. Make sure your contract clearly defines what amounts to canceling the sale and who ends up with the earnest money. ...
- Use an escrow account. ...
- Understand the contingencies. ...
- Meet your responsibilities.
Check the contract for your state
For example, the standard California residential purchase agreement states that the offer “shall be deemed revoked and the deposit, if any, shall be returned to Buyer” if the seller fails to accept the offer by 5 p.m. on the third day after the buyer signed the offer.
Can a seller accept another offer while under contract? ›
While laws vary by state, in general, up until that contract is signed by both parties—even after counteroffers have been sent out—all new offers can be considered and accepted. Once both parties have signed it, however, the seller is pretty much locked into the deal.
What happens if you buy a house and something is wrong? ›
If you discover material defects after the real estate transaction has closed, you may have an action for breach of contract. A qualified, local real estate attorney with experience in housing and construction defects can help you understand your rights and draft an appropriate demand letter.
What happens to the deposit if a purchase agreement is Cancelled? ›
If a real estate contract is canceled, the disposition of the earnest money deposit can vary depending on the terms of the contract and the reason for the cancellation. Typically, the deposit is held in a neutral escrow account and released according to the terms of the contract or as agreed upon by both parties.
What happens if my buyer pulls out? ›
If a buyer does pull out before you've exchanged contracts then, as a seller, you're liable for any fees up until that point. This includes survey costs, solicitor fees and mortgage arrangement costs. This will ultimately depend on lots of different factors but commonly comes down to: The buyer's chain being broken.
Why would a seller ask for more earnest money? ›
If the housing market is intensely competitive, sellers might ask buyers to provide above-market earnest money. If buyers want to get an edge on other bidders, they could provide more earnest money than expected to show how serious and financially stable they are.
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