Can You Lose Earnest Money?

Earnest money serves as a good-faith deposit a buyer provides in a real estate transaction. This deposit demonstrates a buyer’s serious commitment to purchase a property. It is typically held in a neutral third-party escrow account, managed by an escrow agent, title company, or attorney, until the transaction concludes. The amount of earnest money can vary, often ranging from 1% to 3% of the home’s purchase price, though it can be higher in competitive markets. Sellers often expect an earnest money deposit as it signals the buyer’s sincerity and provides assurance if the buyer decides not to proceed without a valid reason.

Circumstances for Forfeiture

A buyer risks forfeiting their earnest money if they fail to uphold their obligations outlined in the purchase agreement. This can occur if a buyer breaches the contract without a valid contractual reason. Such a breach signifies a buyer’s default, allowing the seller to claim the earnest money as compensation. The earnest money acts as liquidated damages, a pre-determined amount the parties agree upon to compensate the seller if the buyer defaults.

Forfeiture commonly occurs when a buyer removes contractual contingencies and then backs out without a valid reason specified in the contract. Once contingencies are waived, earnest money becomes increasingly at risk, often non-refundable. For example, if a buyer changes their mind after contingencies expire or are waived, the earnest money will likely be forfeited.

Failure to perform specific contractual obligations also leads to forfeiture. This includes failing to secure financing after removing a financing contingency, or failing to close on time due to the buyer’s actions. Missing key contractual deadlines, such as for documentation or inspections, without agreed-upon extensions, can also result in the seller retaining the deposit. If the seller fulfills their duties and the buyer withdraws for reasons not protected by the contract, the earnest money can be lost.

Contingencies and Protection

Contingencies are specific conditions within a real estate purchase contract that must be met for the agreement to proceed. These clauses allow a buyer to withdraw and typically receive earnest money back if a specified condition is not satisfied. If a contingency is not fulfilled, the buyer usually has the right to terminate the contract without penalty, safeguarding their deposit.

A common protective clause is the financing contingency, making the purchase dependent on the buyer securing a loan. This ensures that if a buyer cannot obtain a mortgage despite good-faith efforts, they can exit the agreement and reclaim earnest money. An inspection contingency grants the buyer the right to have the home professionally inspected. Should the inspection reveal significant problems, the buyer can negotiate repairs, request a price reduction, or withdraw and recover their deposit. Buyers typically have 7 to 10 days to conduct inspections and raise objections.

The appraisal contingency stipulates that the property must appraise for at least the agreed-upon purchase price. If the appraisal comes in lower, this contingency allows the buyer to renegotiate the price or cancel the contract and retain earnest money. A home sale contingency protects buyers who need to sell their current home before purchasing a new one. This contingency allows the buyer to back out and receive earnest money if their existing home does not sell within a specified timeframe. To ensure these protections are effective, buyers must adhere to all deadlines and provide proper notice when exercising a contingency.

The Process of Release or Forfeiture

When a real estate contract is terminated, handling earnest money involves specific procedural steps, whether returned to the buyer or forfeited to the seller. The earnest money is held by a neutral third party, such as an escrow agent, title company, or attorney, who cannot release funds without explicit instructions. This ensures the money is secure and not directly accessible by either party during the transaction.

In most cases, for earnest money to be disbursed, both buyer and seller must sign a mutual release form. This document directs the escrow holder on how to distribute the funds. If both parties agree on the contract termination, the escrow agent will promptly release the funds as instructed, typically applying them towards the buyer’s down payment or closing costs if the sale closes, or returning them to the buyer if refund conditions are met.

Disputes can arise if the buyer and seller disagree on who is entitled to the earnest money. If a disagreement occurs, the escrow holder will continue to hold the funds until the dispute is resolved. Resolution may involve mediation, arbitration, or legal action. This process can tie up the earnest money for an extended period, preventing either party from accessing it. If it is determined that the buyer defaulted on the contract without valid cause, and the seller is entitled to the funds as liquidated damages, the escrow holder will release the earnest money to the seller, usually after a signed release agreement or court order.