In real estate transactions, there are several steps between making an offer, signing a real estate purchase agreement, and completing the transaction. During those steps, any number of problems can arise. Those problems may cause the buyer to want to, or even be forced to, back out of the transaction.
In order to avoid the outcome, and ensure good faith commitment, the seller may require earnest money.
Earnest money is a deposit made by the buyer to show the buyer’s good faith intention to complete the transaction. Typically, the earnest money is a relatively small amount compared to the amount of the purchase price, but enough that there is a financial consequence if the buyer walks away.
The purpose of a deposit is to mitigate the risk that, when it comes down to it, someone will not or will not be able to pay. Earnest money is no different. The question is: how much risk is there that the buyer will walk away before closing?
If the buyer walks away, the seller is left back at square one, having lost time and potentially money during the process. Risk factors for that occurring typically revolve around financing, but could also involve problems arising with the title or issues uncovered during inspection or appraisal, if the buyer has the right to back out of the transaction in the purchase agreement.
Earnest money is a good idea to provide some compensation if the deal falls apart.
The purchase agreement should provide terms regarding earnest money, likely stating the exact amount and time within which it needs to be deposited. Once the agreement is signed, the buyer will deliver the earnest money, often by check, to an escrow agent or attorney acting on behalf of the transaction.
This is an important point because the earnest money does not belong to the seller yet. It will be disbursed to one party or the other depending on what occurs during the closing process. There are situations in which the buyer may receive the earnest money back, such as if the seller decides to walk away from the transaction.
The escrow agent or attorney will then hold the earnest money until it is required to be disbursed by the agreement or at closing. If the transaction closes normally, the earnest money is credited against the buyer’s closing costs.
Earnest money is a helpful tool for the seller. It can keep a transaction moving even when problems arise. Earnest money is still technically the buyer’s money until the agreement requires it be distributed to the seller.
The information provided in Peak Title Professionals, does not, and is not intended to, constitute legal advice. All content is for general informational purposes only and is not intended to provide a complete description of the subject matter. Specific processes will vary based on applicable law. The title and closing process will be handled by a third-party attorney to the extent required by law. Product offerings vary by jurisdiction and are not available or solicited in any state where we are not licensed.
