Earnest Money Deposits: Everything You Need to Know

Oct 3, 2021 | Contractor Agreements, Purchase Agreements, Real Estate Law

Why Require An Earnest Money Deposit

An Earnest Money Deposit, also known as a good faith deposit, comes from the prospective home buyer and it shows the buyer’s commitment to the seller that they are serious about purchasing a seller’s home. Once the buyer provides the seller with a signed purchase agreement along with the earnest money deposit, the seller agrees that they will stop marketing the home while the purchase transaction moves towards a closing with a title company or other escrow company.

How Much Earnest Money?

The typical earnest money deposit required by a seller is around 1% – 3% of the sale price and is held in an escrow account until the sales transaction is complete. The figure is usually negotiated between the buyer’s real estate agent and the seller’s real estate agent. The amount that a purchaser should put down as a good faith estimate will depend on the activity in the real estate market and / or market location. For instance, when house sales activity is high, and buyer demand is high, the buyer’s required earnest money deposit will generally be higher than in slow real estate markets for a seller to take their home off the market.

Seller Retains Buyer’s Deposit

Usually, if the transaction is canceled due to the buyer’s failure to follow the terms of the purchase agreement, then the seller has a right to retain the buyer’s deposit and then relist and remarket the home. Some examples of a buyer’s default under a purchase agreement, are their failure to obtain mortgage financing; failure to perform a timely home inspection, or the failure to show up at closing.

Seller Refunds Buyer’s Deposit

When the transaction gets to the closing table, the Earnest Money Deposit will be credited towards the buyer’s total purchase price and costs at the time of closing. However, if the sales transaction falls through because a contract contingency is not met, then the earnest money deposit needs to be returned to the buyer. For example, if the home does not pass the buyer’s home inspection, or if title to the property is clouded, then the buyer can cancel the transaction and demand the return of their earnest money.

Examples of Earnest Money Deposit and Contingencies

Example A: the buyer offers a purchase price that is accepted. The buyer states in the purchase contract that if the home does not pass inspection, the transaction is void and the earnest deposit is returned.

Example B: the buyer to the sales contract places a financing contingency into the agreement. The time to make a mortgage application and obtain a mortgage approval is 45 days. The mortgage loan process takes longer than 45 days and the buyer learns that their credit score has declined and they are not approved. According the their sales agreement, they lose their deposit because they exceeded the 45 days to get an approval. They do not get their good faith deposit back because they were not approved.

Example C: the buyer is in a highly competitive market. There are bidding wars and the buyer waives their home inspection. The mortgage lender still requires the home to go through the appraisal process. In the appraisal, the appraiser notes some structural damage. The buyers gets cold feet and wants to back out of the deal. They want their considerable deposit money back because of what the appraisal report reveals. Since the parties waived their home inspection, the seller can cause the real estate purchase agreement to proceed. The buyer will lose the earnest deposit since there was no sale contingency related to the condition of the home.

Example D: Sally and Tom want to buy a home listed for $200,000. The seller, in a very active seller’s market, tells Sally and Tom that her acceptance of the purchase offer will require a 5% non-refundable earnest money deposit if the failure to close is due to the fault of the buyer.

Sally and Tom have a child. It is important to them to send their child to a school located in the school district where the new home resides. As a contingency to the purchase agreement, they need to confirm that the school will accept their child’s application to attend. They write into the agreement that they have up to 10 days from the date of the signed agreement to obtain the school approval; they can notify the seller within the 10 days that they are canceling the transaction if their application is denied and get their earnest money back.

The school approval comes on day 15, and the buyers have found another home that they like better and now want to back out of the agreement. They call the seller for their earnest money back. The seller is in their right to refuse to return the earnest money because the cancelation date exceeded the date agreed in their contract. Moreover, the application was never denied. It was approved.