When a real estate deal completes, the buyer's earnest money is used at closing as part of the purchase price.
However, when real estate transactions fall apart, earnest money is refunded to the buyer if the buyer has the right contingencies in place. If the buyer does not have contingencies, that earnest money is usually non-refundable and is forfeited to the seller.
The most common contingencies that can be used for an earnest money refund include the inspection, financing and appraisal contingencies.
Your purchase agreement will specifically state that the buyer is allowed to cite the contingencies listed and cancel escrow without losing the earnest money.
Contingencies operate on a home sale timeline and have have specific dates by which they need to be removed. For example, the inspection contingency usually has a time frame of 7-10 days after an offer has been accepted. During that time, the buyer has the right to purchase a home inspection and decide whether or not they want to go through with the sale.
But if the buyer misses that time frame, it's not always the case that the contingency is automatically removed. Depending on the contract and local laws, additional action may be required to remove the contingency.
In California, the earnest money deposit can only be released when both the buyer and seller sign a form. The California contingency removal form must be used before any contingency is removed from the contract.
If the contract is non-contingent and all contingencies were waived, then in almost all instances the earnest money is not refundable if a buyer backs out of the deal.
Read your purchase contract thoroughly and speak with your realtor if you have questions about local laws. If you're looking for a great agent, we recommend our partners at Clever Real Estate. Clever offers a free agent-matching service which can connect you with pre-vetted, top-performing local agents who can get you up to 0.5% cash back on home sales over $150,000! That's extra money in your pocket after closing to use on whatever you want, just for using a Clever agent.
Disputes Over Earnest Money When a Deal Falls Through
Earnest money is held in trust by an escrow agent, title company or attorney. Usually, it's clear from the contract as to when the earnest money is refundable and when it isn't.
However, if there is a dispute, you'll need to get involved in a lawsuit or arbitration. Small claims court is an option if the amount is small enough (that amount depends on state laws, usually less than $5,000 or $10,000).
Earnest money disputes can be a big headache for the seller. Litigation can prevent the seller from selling their home to another buyer because the seller would still technically be in escrow until the earnest money dispute is settled.
Usually it is in the seller's best interest to refund the earnest money to the buyer so they can go about their home sale.
If contingency removal dates have passed and the buyer is unable to close, the seller can serve a notice to perform, which is often one of the first steps in cancelling a contract. If it's clear from the contract that the escrow deposit is forfeited, then the seller should be able to retain the deposit.
If you're buying a house but need to cancel the deal, a realtor will be able to tell you if you're in danger of losing your deposit. While it's not ideal, forfeiting a relatively small amount of money to get out of an expensive home purchase is sometimes the best option.
Speak with your realtor if you don't think the house you're looking at is the right one for you. If you need a great agent, our friends at Clever Real Estate can connect you with pre-vetted, local agents for free. Clever is a nationwide low commission brokerage that pre-negotiates low rates and passes the savings on to you. Buyers in 41 states can get 0.5% cash back for sales over $150,000, just for using a Clever agent! And if you're a seller, Clever can sell your home for just a 1% fee or $3,000.
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