Homes fall out of escrow. Often it’s over repair negotiations or a low appraisal. But for various reasons, not everyone gets their earnest money back.
To protect yourself from not losing your earnest money it’s essential to first understand the contingencies in place to protect it. These contingencies are the homebuyer’s right to cancel and receive the earnest money deposit back.
This article gives you the start-to-finish of earnest money in the home buying process—with a strong emphasis on how to protect against losing it.
Earnest money is a good-faith deposit of funds made by home buyers to show sellers they are serious enough about buying the home they will risk their own money.
The amount of earnest deposit is typically one percent of the home’s purchase price rounded to the nearest thousand. For example, if you’re buying a $500,000 home, you would likely put down $5,000 in earnest money. But buyers can offer any amount they’re comfortable with, large as a negotiation tool, or small to protect your risk.
How does earnest money work?
Earnest money is delivered to an escrow account—typically by wire—within twenty-four to forty-eight hours of offer acceptance. When a buyer makes an offer on a home, they include how much earnest money they are willing to commit to.
If the seller accepts the offer, the earnest deposit is held in an escrow account throughout the escrow period.
When the home purchase is complete, at closing, the earnest deposit is contributed towards the buyer’s downpayment or closing costs.
How can you lose your earnest money?
If a buyer backs out of a purchase contract for reasons not specified in the contract, they forfeit the earnest deposit. But, if a buyer is within their due diligence period they may cancel without risk.
The due diligence period has a deadline, just like the rest of the contingencies protecting your earnest money. And missed contingency deadlines are the most common way buyers forfeit their deposits.
When you make an offer on a home, these contingency deadlines are outlined and can be negotiated. It’s essential to track these dates and complete your inspection, appraisal, and loan approval within the set timeframe.
A quick explanation of contingencies
A contingency is a future event or circumstance which is possible but cannot be predicted with certainty. In real estate, contingencies are prerequisites of the purchase agreement that protect the buyer until that condition is certain.
The three significant contingencies in real estate are due diligence, appraisal, and loan contingency.
Due Diligence Contingency
The due diligence contingency is in place to protect the buyer if they uncover major structural or mechanical issues with the property during their inspection period. During the due diligence, a buyer hires a licensed home inspector to complete a non-destructive inspection of the home.
If issues arise during due diligence that causes the buyer to believe the home is unsuitable, they can cancel the purchase agreement and receive their earnest deposit back.
The appraisal contingency is in place to protect the buyer if the home’s appraised value comes back lower than the purchase price. If both parties can not agree on a negotiated purchase price, buyers can cancel and receive their earnest money back.
The lender orders the appraisal, which can take 10 to 15 days. Your agent should work closely with the lender to verify how much time, on average, appraisers are taking before making an offer.
The financing contingency is in place to protect the buyer if they cannot obtain financing to purchase the home.
A lender’s pre-qualification must accompany all offers to show a seller that a buyer is qualified. However, unexpected liens or previous collections may resurface during the home buying process.
Complete tax returns and financial documentation can paint a different picture from what a lender first saw from running credit and previewing information from a borrower.
It’s always critical that you work closely with your lender and promptly send all necessary paperwork when asked for it.
Additional ways to cancel and receive your earnest money back.
Depending on your state and if the home is in an HOA community, you may have the right to cancel and receive your earnest money in full upon reviewing and declining the HOA resale package.
For example, in Nevada, the law states a buyer may take five calendar days to review the HOA resale package. If you don’t accept the terms of the homeowners association, you have the right to cancel and receive your earnest money deposit back.
If the home’s quality or livability has been seriously impacted since completing the home inspection, repairs have not been completed, or contractual agreements have been broken—like missing appliances—a buyer may cancel. These facts would be discovered during the final walkthrough, typically two to three days prior to closing.
The seller has the right to correct any conditions found during the final walk-through to prevent the transaction from canceling.
How is earnest money paid?
Once an offer is accepted, the agent will open escrow with a pre-determined title company. The title company provides the buyer with wire instructions to send the earnest deposit. A buyer may be able to provide a certified check if wiring funds are not available.
The title company maintains possession of the earnest deposit until closing.
At closing, the buyer signs a contract to purchase the property and wires funds for the remainder of the down payment—minus the earnest money already paid.
What happens to your earnest money if you waive your contingencies?
If a buyer waives their contingencies, then the buyer is accepting to purchase the property no matter what. If an issue arises during the inspection or appraisal that you’re not happy with, you will still purchase the home.
Similarly, if you’re unable to obtain financing, you will still need to come up with the cash to pay for the home. You will likely forfeit your earnest deposit if you cannot do this.
Sellers may also ask for an additional earnest deposit if buyers waive their financing contingency since it’s a higher risk for the seller.
Your earnest money will remain in escrow during the purchase period; however, if you have waived all major contingencies, the risk of losing your earnest deposit is exponentially higher.
Sellers can request the earnest money to be released early.
The earnest deposit may become a bargaining tool during the escrow process for the seller. For example, if the buyer asks for significant repairs or needs to extend the close of escrow. A seller may only agree if the earnest deposit “goes hard.” When earnest money goes hard, the buyer agrees to release the deposit to the seller with no recourse.
The deposit will still be credited to the buyer to offset the down payment or closing costs.
Earnest money is an integral part of the home buying and selling process and should be considered carefully by both buyers and sellers. Always read the purchase agreement and all additional contracts thoroughly.
Once you are in contract, your agent’s responsibility is to protect your earnest money. Your agent needs to observe the contingency dates and keep you on schedule.
If you have questions about your earnest money during the transaction, you can always ask your escrow officer. In the end, it’s their responsibility to follow the signed contract for all terms, including the release of earnest money.
Happy home buying!