In a perfect world, every real estate deal would go through seamlessly and all parties would be deliriously happy. The reality is that obstacles can sometimes rear up during the closing process. 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 Escrow?
Escrow is an arrangement in which transacting parties retain an escrow agent as a third party. The escrow agent’s job is to safeguard funds and assets according to conditions that have been agreed upon in advance. Such an arrangement protects the transacting parties in the deal, providing that neither has an unfair advantage and that both are earnest about the deal.
In the event that the terms of the agreement are not adhered to, it is generally easier to reverse the escrow and make the parties whole than it would be if the parties were merely contracting directly with one another. Take the simple example of a buyer placing money into an escrow account as a gesture of good faith regarding a transaction. If the conditions set forth in the escrow agreement not be met by the seller, it is easy to refund the deposit back to the buyer. Similarly, should the buyer default under the terms of the agreement, the seller would have access to the deposited funds.
What is Earnest Money?
Earnest money is a dollar amount buyers put into an escrow account after a seller accepts their offer. Buyers do this to show the seller that they are entering a real estate transaction in good faith. It gives the seller peace of mind to go forward into the next steps of the transaction. It proves you are sincere—or earnest—about this purchase. While you wait to close on your house, the money is deposited into an escrow account with the seller’s broker, title company or escrow company.
Earnest money is important because once you enter into a real estate contract with the seller, the home will then be taken off the market as you go through the process of having a home inspection and closing on your mortgage. Earnest money protects the seller against you changing your mind midway through the process and backing out of your purchase contract, leaving that seller to have to start fresh and list that home all over again.
How Earnest Money Works
Earnest money is typically required when a seller accepts your offer because it shows that you are serious about the purchase. In exchange, they will take the home off the market and assume you will move forward with the appraisal, home inspection and other steps toward closing on the home.
Your real estate agent and the seller’s agent will negotiate how much earnest money you will have to pay and how, when and where the money will be sent. Buyers usually provide a check or money order to cover the earnest money, although it is becoming more common to transfer the money digitally.
The earnest money should be held by a third party—usually a title company or in an escrow account—until closing, when the money can be used toward closing costs or the down payment.
What Happens If the Deal Falls Through?
What happens to the earnest money deposit depends on why the deal is not going through. There are many things that can happen. If the home doe s not pass inspection, the buyer may want to walk away. The appraisal process might also affect the earnest money deposit. If there is an appraisal contingency that states the home must appraise for the purchase price and it does not, the buyer will not be required to proceed.
The buyer being unable to sell his own home is another reason a sale could fall through. In real estate circles, this is known as a home sale contingency. The seller failing to stick to a moving out schedule is yet another problem that creeps up from time to time.
The buyer can expect your earnest money back if:
- The home does not pass inspection
- The home appraises below its sale price
- They are unable to obtain a mortgage
- The home has title search issues
The buyer might not get your earnest money back if:
- They do not meet the deadlines listed in the contract for inspections and appraisals
- They simply change your mind
What to Do in a Dispute Over Earnest Money
The purchase contract is the first resource to consult when a dispute has arisen over whether earnest money should be returned to the buyer. The terms of the contract will govern the parties’ next steps. Often, the contract or state law will require that the parties attend mediation or arbitration before anyone can bring a suit to recover the money. 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 reimbursement for attorney’s fees that are accrued during the filing of the interpleader action.
Unfortunately, there will be times when the parties exhaust their pre-litigation options or requirements and cannot reach an agreement over the distribution of the earnest money. At this point, the matter will have to be decided in the courts. If the amount of the earnest money is small enough, small claims court may be an option, depending on your state’s criteria and monetary limits for these courts. Otherwise, a court of general jurisdiction will be able to hear and resolve the matter, but it will likely be a longer process during which neither the buyer nor the seller will have access to the earnest money funds.
As a seller, be aware that you will not automatically get earnest money if a buyer drops out, but you may be entitled to it when a buyer is in breach of the terms of the contract and does not complete the purchase.
So when answering the question “who keeps the earnest money when a home sale falls through?” it boils down to who violated the terms of the contract. If a buyer defaults on one of their commitments or time frames, they will lose their money. If, however, the buyer backs out of the transaction due to one of their contingencies, the seller will not be able to keep the earnest money.
When choosing an escrow company there can be many important factors to evaluate. Fees, location, staff and even recommendations from friends and colleagues are all things to consider. With Citrus Heritage Escrow by your side, you can rest assured that when you receive your settlement check, you’ve gained the maximum benefit from your home sale or purchase.
Call us today with any questions or concerns. Our professional Escrow Agents will help you through this exciting yet confusing process. (951) 335-7200