Did you know that around 5 percent of pending home sales end up falling through? In a typical home sale, the earnest money deposit converts to part of the buyer’s down payment or applies to closing costs. But despite the best efforts of the parties involved, home sales sometimes encounter an issue and the purchase is not completed. In what scenarios will the buyer forfeit the deposit and in which situations will the buyer receive a refund of the deposit?
Overview of the Earnest Money Deposit
The earnest money deposit represents the buyer’s intention to buy a house. Also known as a good faith deposit, the funds signal the buyer’s sincerity in the offer to purchase the home, and serves as compensation for the seller to remove the property from the market.
Depending on the market, the deposit usually equals one to two percent of the purchase price, but sometimes ranges up to 10 percent of the price. In competitive markets, the buyer might include the deposit as part of the offer, but in most markets the deposit is paid upon execution of the purchase agreement. Funds are held in escrow. The conditions surrounding the earnest money 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 buyer backs out of the deal under certain circumstances, the buyer forfeits the earnest money deposit. For example, if the buyer chose to waive contingencies in the purchase agreement and then decides to abandon the purchase, the deposit forfeits. A contingency clause in an agreement outlines 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 purchase, the buyer forfeits the deposit. The most common reason for forfeiting the deposit is the buyer simply changes their mind and pulls out of the sale.
Reclaiming Your Earnest Money Deposit
There also are several reasons why a buyer would receive the earnest money deposit back. The purchase agreement might specify certain reasons in which the deposit could be reclaimed, 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 in advance of closing on the home purchase, a title review occurs. A title company, usually, 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 title. If the buyer encounters issues with the title, then the buyer can back out of the agreement and receive the earnest money deposit.
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 for some reason, then the agreement is forfeited and the deposit will be returned to the buyer.
3. Low Appraisal Value
The mortgage company 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, then the buyer can walk away from the sale and retain 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, then the buyer can request a lower sales price, require the owner to make specified repairs, or cancel the purchase agreement and keep the deposit.
5. Current Home Remains Unsold
If a buyer is simultaneously selling a property while attempting to purchase another, then the buyer commonly includes a 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, then the buyer can walk away from buying the new home. With this contingency, the buyer retains the earnest money 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 buyer did not complete agreed-upon repairs or renovations. If this happens, then the buyer can void the contract and expect a return of the earnest money deposit.
7. Seller Cancels the Contract
Sometimes, the seller changes their mind and decides not to sell the property for some reason. If the seller terminates the contract, then the buyer will get the earnest money deposit returned.
Releasing the Earnest Money Deposit from Escrow
In most U.S. jurisdictions, the earnest money deposit, held in escrow during the contract period by a title company, lawyer, broker, or bank, must be returned within a brief period of time, usually 48 hours, when a buyer properly walks away from a deal. Buyers should check the laws applicable to their 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 holder will continue holding the funds until the dispute resolves.
A Better Way to Make an Earnest Money Deposit
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