What is Earnest Money
In the process of buying a home, when the buyer has completed all due diligence and is ready to close the deal, a sale/purchase contract is drawn up.
Most sellers ask for an earnest money deposit to be made at this stage and the amount deposited is generally adjusted against the sale consideration.
There is no legal compulsion, on the part of the buyer, to pay the earnest money in order for the contract to be valid. However, from a practical point of view, when the seller agreed with the buyer on the terms and prices, some form of financial binding statement is necessary for him to “de-list” the property as sold. This way, it is easier for both parties to proceed with measures for conveyance of the property after appropriate documentation.
In the absence of a legal stipulation, the buyer and seller are at liberty to discuss and arrive at a mutually agreeable amount of earnest money deposit. Often times, this is a small percentage of the total value of the property under sale. This percentage can however, vary between different types of properties like vacant land, commercial property, residential homes, etc.
Earnest money is never paid directly to the seller. Generally, the earnest money is placed with the seller’s agent or buyer’s agent (an agency agreement is needed). The purchase/sale agreement will specify where the earnest money will reside pending closure of the transaction. Generally, a trust account or an escrow account is nominated. This account can also specify the conditions of how to handle the earnest money, if the transaction fails to close. Earnest money generally does not bear any interest, but when it does, the purchase/sale agreement also qualifies the beneficiary for the interest earned.
Any refunds of earnest money once paid, is governed by conditions laid down in the purchase/sale agreement. A breach of contract by the seller is often enough evidence to claim reimbursement of the earnest money previously paid. The process of establishing the breach of contract is never easy and home buyers are more likely to need help from experienced attorneys. In such situations the buyer may also claim other financial damages depending on the specific circumstances of the transaction.
When the buyer fails to close the transaction, the earnest money is generally forfeited. If that occurs the seller has a right to seek specific execution of the sale/purchase contract. In such situations, it is likely that the courts will intervene to determine the causes. If the failure to close the transaction occurred due to contingencies outlined in the purchase/sale agreement, the court decision can potentially go in favor of the buyer. The seller failing to perform his part of the contract will also entitle the buyer to refund of the earnest money deposit. Given the high cost of litigation, a negotiated settlement between the parties to the contract is often desirable while dealing with a refund of earnest money deposit.
Taking help from an experienced attorney is always the best way to deal with issues such as earnest money deposits, especially in property transactions. The state laws vary across the nation and most of us have little or no knowledge of these complex provisions. In the state of California for instance, a buyer can claim return of his earnest money within the first 17 days without attributing any reason for pulling out of the transaction. The seller cannot refuse to part with his rights to the earnest money deposit, without a valid cause. When the seller fails to show adequate cause and continues to refuse release of the earnest money deposit, he could even end up paying $1,000 to the buyer as civil penalty, in addition to refunding the earnest money deposit. In another state, the legal provisions need not be the same, each states laws vary. Be sure to check your local home buying/selling laws for the exact aspects of each law.