DISCLAIMER: This blog post is meant to be used for informational purposes only, not legal advice. If you need assistance navigating the legalities of keeping earnest money from a real estate transaction, HomeLight always encourages you to reach out to your own advisor.
In many cases, if a homebuyer wants to back out of a contract and retrieve their earnest money, they’ll be able to find a way to do so within the confines of the real estate purchase contract. Real estate contracts are generally stacked in the buyer’s favor so that all the way up until the final signatures, they may still have an escape route.
This isn’t true in all cases; there are specific ways that a seller can structure the contract to make it more difficult for a buyer to retrieve their earnest money at the final hour.
In this guide, we’ll outline the scenarios where you’re vulnerable as a seller, where you’re in the right to claim the earnest money due to the buyer failing to uphold their end of the contract, and what things you can do to protect yourself against the risk of a buyer pulling out at the last moment.
What is earnest money?
Earnest money is a deposit from a buyer paid at or immediately after having an offer accepted for a home to indicate that they are serious about following through with the transaction. Earnest money is often referred to as a “good faith” deposit.
The deposit comes with certain conditions and time periods that define when the buyer can terminate the contract and reclaim the earnest money. However, if the buyer terminates the contract for any other reason not specified in these conditions, the seller is typically entitled to keep the earnest money as a concession for the time they took the home off the market to enter into the exclusive agreement.
If a seller terminates the contract outside of these contingencies, they typically must forfeit the buyer’s earnest money and — depending on the circumstances — may even be required to pay additional money damages and face other possible repercussions for breach of contract.
“It’s really good faith money,” says Kelly Allen, a top agent and seller representative specialist in Marietta, Georgia. “It’s there in case the buyer terminates the contract for any reason outside of their contingencies.”
In most cases, real estate purchase contracts are exclusive agreements, meaning a seller can’t continue marketing the home and accepting additional offers once the home is under contract. The danger to a seller in this scenario is having to pay an extra mortgage payment and additional marketing fees if, after weeks of being wrapped up in an exclusive agreement with a buyer, the buyer falls through.
Earnest money is meant to compensate the seller for the time wasted in the event of a failed contract. It can be a powerful tool in negotiations to make an offer stronger: The higher the earnest money, the fewer contingencies, and the shorter the dates connected to the contingencies, the stronger the offer.
Here’s a high-level summary of how earnest money works in a typical real estate transaction:
- The buyer offers earnest money at or within days (usually 3) after the offer is accepted.
- The typical amount is around 1% of the purchase price (ex. $5k for a $500K home).
- A higher amount is a strong indication that the buyer is serious about following through.
- It is usually held in the broker’s or title company’s trust or escrow account until closing.
- The earnest money typically goes towards the buyer’s down payment or closing costs.
- It is refunded to the buyer only upon certain contingencies specified in the contract.
- If the buyer cancels the contract outside of the contingencies, it is released to the seller.
- In competitive markets, earnest money can “go hard” sooner, removing contingencies.
Is earnest money refundable?
The short answer is yes, usually.
Most standard real-estate purchase contracts include three common contingencies that allow the buyer to terminate the agreement and remain entitled to a refund of the earnest money deposit:
- The Home Inspection or Due Diligence Contingency: The buyer specifies an initial period of time to conduct due diligence on the condition of the home, including ordering a home inspection. Suppose the inspection uncovers issues that are unacceptable to the buyer. In that case, they may terminate the contract and receive a refund, but only as long as they do so before the specified deadline in the contract.
- The Appraisal Contingency: This contingency typically only applies to offers that require a mortgage to purchase the property. The buyer specifies a date by which the lender conducts an appraisal of the home. If the appraisal comes in below the purchase price in the contract, the buyer can back out of the contract and receive their earnest money.
- The Financing Contingency: This contingency, sometimes called a mortgage contingency, is also only applicable to offers requiring a mortgage to purchase the property. It is simply a period of time that the buyer sets to secure financing approval from a lender for the purchase of the home. If the financing fails, the buyer can pull out of the contract with a full refund for earnest money as long as it’s before the specified deadline.
There are other possible contingencies that a seller may encounter in reviewing offers, such as a Home Sale Contingency, which allows the buyer to back out of the agreement in the event that their current property doesn’t sell in time.
In competitive markets, this contingency is very unattractive to sellers. However, the seller-focused Kick-Out Clause allows the seller to continue marketing the home and receiving offers. If they get a better offer, they can give the buyer a period of time (72 hours, for example) to either remove the Home Sale Contingency or cancel the contract.
Finally, in very competitive markets, some buyers may choose to remove certain contingencies altogether, and have their earnest money “go hard,” meaning become non-refundable, after a certain period of time (such as after a very short inspection period). Sometimes, buyers may even include the earnest money as non-refundable from the very beginning, something known as “sign-and-go-hard.” While this is risky for the buyer, it can be a good way to have an offer stand out when the seller is receiving dozens within days.
Just be as specific as you can be in the contract. That makes it very black and white, and enforceable. Because the contract says this, and the buyer didn’t do it. Well, then they lose the earnest money.
In which situations can a buyer get their earnest money back?
In a typical market, “It’s really hard for a buyer to lose their earnest money,” says Allen.
If the buyer is working within the guided timeline and purchasing contract, they have several opportunities to break the contract and walk away from the deal with their earnest money.
Here are eight common situations where buyers often get their earnest money back:
1. Issues that arise during due diligence
Most contracts include a due diligence deadline anywhere from seven days to two weeks after the agreement date. During the due diligence period, which can vary by state, a buyer lines up fact-finding research such as a home inspection, appraisal, and title search. In this window of time, the buyer can terminate the contract for basically any reason that has to do with the condition or status of the property.
2. The home’s appraisal comes in low
Usually, the appraisal contingency deadline is two to four weeks after the agreement date. If the home appraises at a lower value than the contracted purchase price, the seller has the option to lower the purchase price to the appraised value to keep the buyer locked into the agreement. If the seller doesn’t lower the purchase price, the buyer can back out with their earnest money.
3. Buyer runs into financing trouble
The financing contingency deadline, on average, is between three and four weeks after the agreement date. If the buyer fails to get approval for a mortgage, the buyer can terminate the contract and remain entitled to their earnest money deposit, basically holding the bank responsible for the failed process.
4. Problems with the seller’s disclosure document
Sellers in most states are legally required to detail many of a home’s flaws in a disclosure document. It’s rare (not to mention illegal on the part of the seller), but if the buyer discovers that the seller has not disclosed known issues with the home, they are more likely to lose trust in the transaction and terminate it. This can happen even if the buyer waives their right to the due diligence deadline.
5. Buyer’s current home doesn’t sell in time
The Home Sale Contingency typically stipulates the buyer will not pay two mortgages at the same time. If the buyer’s home doesn’t sell within the timeline they’ve contractually outlined, they are entitled to their earnest money when they back out of the deal.
6. Title search reveals a lien or ownership issue
Part of hiring a title company includes a thorough title search to ensure that no other parties have ownership claims to the home. If the buyer finds an issue with the title, such as a lien or inconsistencies in ownership, the buyer can void the contract and take back the earnest money deposit.
7. Surprises in the final walkthrough
A final walkthrough isn’t required but is often recommended prior to closing. If any agreed-upon repairs aren’t completed at this time, or fixtures are removed in violation of the sales agreement, the buyer is within their rights to void the contract and take their earnest money.
8. Termination of the deal by the seller
In some cases, the seller may terminate the contract early for a variety of reasons. However, if the seller breaches the contract illegally, the buyer may be entitled to much more than a refund of earnest money, including the ability to force the sale, receipt of an equivalent amount to the earnest money from the seller, and in some cases this may result in a lawsuit.
And then there’s closing, technically
This one’s a technicality, but the buyer will see their earnest money deposit again in the form of a credit paid toward the down payment. “It’s basically a little bit of a prepayment on their down payment,” Allen explains. If the buyer prefers, the money can instead be applied toward their closing costs.
How can sellers keep the earnest money?
While it’s easier for a buyer to terminate a contract and retain their earnest money, there are several scenarios and tactics you can employ as a seller to protect your risk of being tied up in a contract without this consideration (especially in competitive markets).
1. Ask buyers to remove contingencies
You don’t have to accept and sign an offer that includes all of the contingencies above. If you are receiving multiple offers, you can ask buyers to remove contingencies in their contracts. According to HomeLight’s 2022 Buyer and Seller Insights Report, 15% of buyers removed contingencies in their offers to be more competitive.
Additionally, if you receive any cash offers, they may or may not include the appraisal contingency, but won’t include the financing contingency. This is just another reason why cash is king.
2. Issues outside the due diligence period
Once the due diligence deadline has passed, the buyer has less wiggle room to walk away with the earnest money. Getting cold feet or making assumptions outside of the agreed-upon contract aren’t reason enough for a buyer to walk away with the money.
“Just be as specific as you can be in the contract. That makes it very black and white, and enforceable,” Allen says. “Because the contract says this, and the buyer didn’t do it. Well, then they lose the earnest money.”
3. Enforce the “time is of the essence” clause to keep the deal moving
Inserting a standard “Time is of the Essence” (TOE) clause into your contract will help the sale maintain momentum.
The provision stipulates that the specific times and dates in the agreement are mandatory. If dates and deadlines aren’t meant, either party has the option to void the contract. More importantly for the seller, a TOE clause in your deal means that if the buyer can’t close on the home for any reason after the pre-specified deadlines, the seller is typically entitled to receive the earnest money deposit.
4. Ask for part or all of the earnest money to be non-refundable
In competitive markets, you can ask that all or part of the earnest money be non-refundable. This can happen as early as signing the contract or after the first due diligence deadline. In this case, instead of having the entire earnest money amount refundable even at the latest deadline, you can have portions go non-refundable at each deadline. This way, you may still receive a portion if the buyer pulls out during the financing deadline because of portions that went hard after the due diligence and appraisal deadlines.
What happens if there is an earnest money dispute?
No one wants to see the sale of a home fall through. But receiving the earnest money as a seller helps lessen the blow of a delayed timeline.
In some cases, buyers will argue for their earnest money back, even outside of contingencies.
If the deal collapses, and the case isn’t black and white, both parties can formally submit paperwork to the broker advocating for the earnest money deposit. “Then it takes about 10 days for the broker to work out who is actually going to get the earnest money,” Allen explains. “But it can really get down to a case-by-case basis.”
At that point, if the broker sides with the seller, the buyer will be put on notice to forfeit the earnest money deposit within 10 days. “And then the buyer can either hire an attorney at that point or you know, make further cases for it. But it rarely gets to that point,” says Allen.
Bottom line: Navigate earnest money pitfalls with a top agent
Earnest money deposits are a gesture of good faith, but they’re not a guarantee of a sale. In many instances, both the buyer and seller feel entitled to the money when a deal falls through. With a well-established contract, collecting the deposit is pretty black and white.
HomeLight’s free Agent Match platform can connect you with a top-performing real estate agent in your area who has the skills and experience to help you avoid the frustration of a failed sale without receiving earnest money as consideration. A great agent can help you choose the best offer that is most likely to close and manage the home sale to reduce your risk.
Writer Emma Diehl contributed to this story.
Header Image Source: (Katie Wallace / Unsplash)