When you execute a contract to buy a home, you will offer some earnest money to the seller. The contract specifies when you need to provide the earnest money to the seller or seller’s agent and this is normally within a few days of contract execution. This check will be cashed within 24 to 48 hours of being provided so make sure the money is in your account when you write the check. At closing, the earnest money is applied towards any down payment and/or closing costs that you might have. If you are doing a “no money down/no closing cost” transaction (rare these days), the earnest money comes back to you at closing.
Instead of a closing, a contract can end with either a “termination” or a “default”. Here are the differences:
Most contracts allow you to terminate a contract if problems are encountered with inspections, appraisals, insurance, loan approvals or title examinations. Exercising a contingency is not a default since you are just exercising a right granted to you by the contract. You get your earnest money back if you terminate a contact.
A default only occurs when you somehow fail to live up to your obligations under the contract. Examples of defaults might include not showing up for closing or failing to diligently pursue loan approval. You forfeit your earnest money if you default on a contract.
How much earnest money should you offer to a seller? One to two percent of the purchase price is a typical earnest money amount depending on price range and other factors. Of course, the amount of earnest money on any particular deal is a negotiated amount and you may want to offer more or less earnest money based on your particular circumstances and based on other items contained in your offer to the seller. For example, you might offer a lot more earnest money if you are asking for a delayed closing.
When cashed, your earnest money will typically be deposited in a trust account. This is a special account that real estate companies and title companies use to hold other people’s money. These accounts are protected from creditors of the real estate company or title company. A trust account keeps your money segregated from funds that belong to the company. However, with new home builders, it is typical for your earnest money to be deposited in the builder’s operating accounts. These situations are more risky because your money is at risk of loss if the builder has financial difficulties.
Your earnest money typically does not earn interest while it is on deposit. For most transactions, this is satisfactory since the amount of earnest money is usually relatively small and the time from initial contract to closing is pretty short. However, if there is a lot of money involved or if we are going to have an extended contract period, we may want to consider depositing the earnest money with a title company that pays interest on the earnest money.
The holder of the earnest money, whether a real estate company, a title company or some other entity, is not obligated to decide disputes between you and a seller regarding disposition of the earnest money. If a dispute arises, the holder of the earnest money may retain such money until receiving instructions from both the seller and from you regarding such disposition. Most brokers and title companies would hold on to your earnest money if you and the seller are in disagreement over whether the money should be returned to you or given to the seller.
However, an earnest money holder could decide to distribute your earnest money to a seller without your consent. You might have to proceed with legal action against both the earnest money holder and the seller to recover earnest money if you felt it had been distributed improperly. The holder of the earnest money normally has the right to “interplead” the earnest money funds – that is, they have the right to file a legal action where the money is turned over to a court so that the court can subpoena both you and the seller to come to court to resolve the dispute.
Another danger you face when you have earnest money on deposit is that it is subject to improper use and theft. The person in charge of the account might embezzle the money or simply abscond with it.
While these risks are real, they occur very infrequently, in our experience. Most contracts end in a successful closing.