As you might have noticed while working in real estate, there’s always a chance that something will go wrong during the home buying process, changing the terms of the purchase contract or even canceling the real estate transaction altogether. In fact, did you know that around 5% of pending home sales end up falling through? And that can translate to the buyer losing money, depending on the reason for the sale being canceled. After all, home buyers typically pay an earnest money deposit upfront, which can be applied to the down payment or closing costs. But despite everyone’s best efforts, home sales sometimes encounter an issue. So, in what scenarios do home buyers forfeit the deposit, and in which situations will they get a refund? Here’s what you need to know.
What Is Earnest Money?
The earnest money deposit represents the buyer’s intention to buy a house. Also known as a good faith deposit, the funds can signal sincerity in the offer to purchase the home. They also serve as compensation for the seller to remove the property from the market. Depending on the present real estate market, the deposit usually equals 1-2% of the purchase price, but sometimes ranges up to 10% of the price.
In competitive markets, the home buyer might include the deposit as part of the offer. But in the average housing market, the deposit is paid upon execution of the purchase agreement, and the funds are held in an escrow account. The conditions surrounding the deposit, such as the allowable reasons for refunding the deposit to the buyer, are outlined in an agreement.
Forfeiting the Earnest Money Deposit
If the home buyer backs out of the deal under certain circumstances, he or she forfeits the earnest money deposit. For example, if buyers choose to waive contingencies in the purchase contract and then end up abandoning the purchase, they’ll lose the deposit.
A contingency clause in an agreement outlines the conditions that must be met before buying the home. In another example, if the sales contract specifies “time is of the essence” and the buyer fails to meet the timeline to complete the real estate transaction, the buyer forfeits the deposit.
So, what’s the most common reason for forfeiting the deposit? It’s pretty simple: the buyer has a change of heart and pulls out of the sale. In fact, the reason for the good faith deposit is to discourage home buyers from simply changing their mind after agreeing to buy the home. Basically, if you want your deposit back, you have to have a pretty good reason! Fortunately, there are some good reasons that may come up that can help buyers get their earnest money back.
Reclaiming the Earnest Money Deposit
There are several reasons for buyers to get their deposit back. In fact, the purchase agreement will likely specify a few reasons that would allow for this, and the real estate agent and lender should let each buyer know what they are. But typically, the following seven reasons are the most common.
1. Issue with the Title
As part of the due diligence performed by the buyer before closing on the home purchase, a title review occurs. This is when a title company conducts a review of the property’s title, or right to ownership. The title review searches various public records and recorded documents to identify any possible defects to title, which either question the ownership or limit the rights to use the property. Possible defects include outstanding liens, unknown heirs, and clerical errors in transactions. Most purchase agreements include a contingency regarding the title. If the title company identifies issues with the title, the buyer can back out of the agreement and get the earnest money back.
2. Unable to Secure Financing
Most purchase agreements for homes that will be bought with a mortgage include a loan financing contingency. If the buyer is unable to secure financing through a lender that offers home loans—due to a low credit score or any other reason—the real estate transaction is forfeited and the deposit is returned.
3. Low Appraisal Value
The lender usually requires an appraisal of the property to be purchased. With an appraisal contingency, if the house appraises at a value lower than the purchase price and the seller refuses to lower the price, the buyer can walk away from the sale and keep the deposit.
4. Results of Home Inspection
Prior to closing the sale, the buyer usually hires a third party to conduct a home inspection, which examines major systems of the house like heating and cooling, foundation, and electrical systems. If the home inspection reveals major issues, the buyer can request a lower sales price or require the owner to make specified repairs. The buyer can also cancel the purchase agreement and keep the deposit, thanks to the home inspection contingency.
5. Current Home Remains Unsold
If a buyer is selling a property while trying to purchase another, he or she commonly includes a home sale contingency in the sales contract that prevents paying two mortgages at the same time. If the currently owned property does not sell within the contractually specified deadline, the buyer can walk away from buying the new home. With this contingency, the buyer keeps the deposit.
6. Agreed-upon Repairs or Renovations not Completed
During a final walkthrough of the property before the closing date, the buyer might discover that the seller did not complete the agreed-upon repairs or renovations. If this happens, the buyer can void the contract and expect a return of earnest money.
7. Seller Cancels the Contract
Sometimes, the seller changes their mind and decides not to sell the property. If the seller terminates the contract, the buyer will get the earnest money returned.
Releasing the Earnest Money Deposit from Escrow
In most U.S. jurisdictions, the earnest money deposit is held in an escrow account during the contract period by an escrow company, lawyer, broker, or bank. And it must be returned within a brief period of time, usually 48 hours, when a buyer properly walks away from a deal. You should check the laws applicable to your area to learn the specific requirements for requesting the escrow holder release the money. If there is any dispute over whether the earnest money should or should not be returned, then the escrow company will continue holding the funds until the dispute resolves.
A Better Way to Make an Earnest Money Deposit
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