Ah, the Earnest Money, that special sum of money that sellers want a lot of, buyers don’t want to pay period, and that no one figures out the importance of until both parties are spending thousands of dollars in legal fees on trying to get it back or keep it. When it comes to Earnest Money and trying to understand what exactly it is, you really need to answer three questions: 1) what is it; 2) why do we use it; and 3) who gets to keep it.
Earnest Money is essentially the same thing as a deposit for the purchase of Real Estate. In other words, it is like money down on the purchase of the property in question. Generally, Earnest Money is either a dollar figure, like $1,000.00, or some percentage of the total purchase price. Depending on whatever agreement the parties may reach the amount of the Earnest Money could be as low as a couple hundred dollars or as high as 40% of the purchase price. The agreed upon amount is then paid by the buyer to whomever the parties have designated as being responsible for holding on to the Earnest Money. Most often the seller’s attorney, the realtor, an escrow agent, or the seller holds the Earnest Money.
The reason why we use Earnest Money so often in the purchase of Real Estate is mostly for protection and a little in order to keep buyers serious. The idea is, if something goes wrong after the Purchase Agreement is entered into, and the buyer refuses to Close without legal justification, the seller would be able to keep the Earnest Money despite the fact that he was not able to sell his house.
In other countries, Earnest Money is sometimes called caution money. Caution money, like the phrase Earnest Money, tends to hint at a different aspect of the funds, namely, to keep the parties serious and honest about the proposed transaction, hence “earnest.” The idea is that if a buyer has to fork out several thousand dollars to the seller in order to take the property off the market while they investigate the property, then the buyer will be much less likely to run away from the transaction without good reason. If you have ever sold a piece of property that took a fair amount of marketing in order to get people interested in purchasing it, then you know how much work can go into marketing and how much more work has to be done again if you take that property off the market for a time.
Now that you have a better grasp on what it is and why it is used, it is time to discuss who gets to keep the Earnest Money if the purchase of the property does not go through. The easy answer to who gets to keep the Earnest Money if the deal does not go through is that it depends. It depends upon two things: the Purchase Agreement; and why the deal did not go through. The Purchase Agreement will usually be full of various contingencies such as financing, marketable title, inspection, and the like. If the deal does not go through due to the failure of one of the contingencies, then ordinarily, the buyer will be entitled to a return of the Earnest Money. In addition, if one of the parties breaches the Purchase Agreement outright, then the other non-breaching party will be entitled to keep the Earnest Money.
The tricky situations arise where neither of the parties breach, or where neither party is innocent but neither of them breached outright. Situations such as these often end in legal battles. Ultimately, it is important to remember the possibility that as a buyer, the seller may retain your Earnest Money payment even if you do not Close on the property. Remember, Earnest Money can be an important bargaining chip when putting together a Purchase Agreement for the sale of Real Estate, but be careful to protect your interests as either a buyer or a seller.
Common Terms in a Purchase Agreements