Selling issues

C - Earnest Money: Does it provide any security?

Buyers want to show that their offer is being made in “earnest”, so they submit their bid with money (a check). It's called a binder, a good faith deposit or earnest money deposit. 

It may or may not be that important, depending on the amount, the length of time until the closing, the purchase contract provisions and local laws.

Important to know:

Legally, earnest money does not belong to you, even if it’s given to you by the buyers. A third party such as an escrow agent, an attorney or a real estate agency should hold it. It is applied to the purchase price at closing.

Some buyers will stipulate in their offer that the earnest money will be presented when their inspection is completed. This is their way of not putting their money on the line until they feel comfortable about the all important home inspection. This is a smart move on their part and one that isn't usually disputed by the sellers unless it’s a very desirable property.

If the deal falls through because a contingency cannot be met, then the buyers usually get their earnest money back, depending, of course, upon how this was specified in the contract.

The amount:

The actual amount of earnest money is driven by tradition, varying from area to area. It can be as small as a few hundred dollars to as high as several percent on more pricey properties or in highly competitive markets. An amount that is around two percent is very common, and rarely does it go over ten percent. Agents, attorneys and title companies can recommend what’s traditional for your particular priced home in your area.   

Buyers may try to impress you with an excessive amount of earnest money during the negotiations. Large amounts are commonly used in multiple bid situations as hopeful buyers attempt to gain a favorable edge.

A large amount provides you with a nice feeling of security, but who has claim to it in a failed transaction may have to be decided in a court of law. It all depends on how its disposition is spelled out in the contract. This is one of those items that your attorney should review.

The longer the time period until the closing, the more important the earnest money becomes. From the standpoint of time, a sale that will close in two to three weeks is less risky than one that is scheduled to close in several months. A longer time period simply allows more time for something (job loss, loss of financing, property damage, etc.) to go wrong.  

When the sale dies:

In some states, the buyers can get their earnest money deposit back with relative ease if they legitimately fail to meet a contingency and the sale falls through. In these situations, the actual amount of earnest money is not that important.

However, when a sale falls apart because the buyers simply back out of the contract, you’ll make your best case for laying claim to the earnest money. Even then, you and the buyers undoubtedly have to sign off on this, otherwise court action is often undertaken to settle earnest money disputes.

Until the earnest money issue is resolved, the buyers could still be considered to hold an “interest” in the property. This means that you could have some difficultly selling your house until this issue is put to rest. This is another reason for you to engage the services of an attorney.

As buyers become vested:

As time progresses and contingencies are met, there is less of a risk of having to give the earnest money back to the buyers. Therefore, during negotiations, the seller might consider inserting (under legal guidance) a stipulation in the contract stating that when a specific situation is met, the earnest money will be increased to some agreed upon amount. Performing repairs agreed upon as a result of the inspection is a logical example.

This is usually only done if the initial amount was smaller than normal. It becomes that much harder (and less likely) for the buyers to try to back out if all contingencies are met and the earnest money amount is significant.

You can take heart when buyers pay to make mortgage application, pay to have a home inspection and pay for an attorney. The more the buyers have invested financially in the transaction, the more committed they are to its completion.

Seller's earnest money:

Buyers can request that you put up earnest money. Thus, if you don’t perform (as an example, move out as specified in the contract), then the buyers could lay claim to this earnest money.

This is more common in major metropolitan areas where attorneys like to cover all the bases and demonstrate to their buyer clients that they’re looking out for their best interests. Or to put it another way, where nobody trusts anybody.