Earnest Money Contract: How They Work

What is an Earnest Money Contract?

An earnest money contract is a legally binding document between parties made during the exchange of the earnest money. Earnest money is a monetary deposit made by the buyer in a home loan or real property transaction, and it’s typically held in escrow by a third party. Generally, the earnest money can be anywhere between 1-10% of the sale price. The earnest money contract generally sets the conditions for refunding the deposited amount.

Here is an article on earnest payments.

How Earnest Money Contracts Work

Earnest money protects the seller if the buyer backs out of a sale. An earnest money contract protects both parties by setting terms and conditions of the earnest money refund. It also provides remedies for both parties in case of a breach of contract or dispute.

Generally earnest money contracts contain crucial information pertaining to the sale and the exchange of the earnest money–such as contingencies, timeline of exchange, refund process, escrow agent, etc.

Here are some examples of how earnest money works.

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Key Terms in an Earnest Money Contract

Earnest money contracts set the terms and conditions of refunding the deposited earnest money and provides remedies in case of breach of the contract. Here are some of the key terms you are likely to encounter in an earnest money contract:

• Buyer and seller details: An earnest money contract will contain the information about the buyer and the seller to establish the parties that are entering the agreement.
• Escrow agent information: The earnest money is generally held by an escrow agent agreed to by the parties involved in an escrow account . The escrow agent can be the seller’s attorney, the real estate agent or an agent of the title company or a third party, although it is important that the escrow agent be able to act impartially. In case of a breach, the escrow agent may return the amount to the seller and in case of a dispute the escrow agent might hold the earnest money till the dispute has been resolved.
• Amount of deposit: There is no rule about how much earnest money has to be. Generally, this ranges from 1-10% of the sale price. The earnest deposit contract will note the amount of the deposit being held.
• Property details: The earnest money contract will also contain information about the property being sold. It may also note the purchase price, representations and warranties, financing, mortgage note , title insurance , closing costs , lead-based paint disclosure and other relevant details of the sale, although these details may instead be included in a separate purchase agreement instead.

Contingencies:

Contingencies are an important part of earnest money contracts. These contingencies provide buyer protection by ensuring refund of the earnest money in case of certain special events. Here are some common contingencies used in earnest money contracts:

• Mortgage contingency clause: A mortgage contingency clause can be used when the buyer is purchasing real estate through a mortgage. This clause would ensure that if the buyer is unable to secure mortgage and complete the sale, the earnest money deposit will still be returned to the buyer.
• Inspection clause: An inspection clause allows the buyer to have certain amount of time to conduct home inspection for any issues. If the home fails this inspection and the buyer backs out of the sale, the earnest money can still be returned to the buyer if the inspection clause has been added to the earnest money contract.
• Appraisal contingency: An appraisal contingency allows earnest money refund in case that the appraisal, or appraised value, of the real estate is lower than the sale price.
• A contingency for selling an existing home: A contingency for selling an existing home makes the sale contract contingent on the sale of a current home. If the current home doesn’t sell and the sale doesn’t go through, this type of contingency still allows for earned money refund.

If you would like to learn more about contingencies in an earnest money contract, here is an article.

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Can I Get My Earnest Money Back?

Earnest money contracts have contingencies that protect both the seller and the buyer. In case a sale goes through, earnest money is generally refundable. Contingencies set out more terms under which even if the sale doesn’t go through, the earnest money is refundable.

However, if the buyer backs out or the sale is incomplete due to reasons not set under contingencies in the contract, the seller can forfeit the earnest money.

Here are some ways you can protect your earnest money.

What Happens to Earnest Money at Closing?

If the appraisal is completed and both the buyer and the seller is happy with the price and the inspection is completed without trouble, the buyer and seller move to closing. At closing, the buyer pays the seller and receives the rights to the property. At this time, the escrow agent will pay the buyer the earnest money which was being held in escrow. Sometimes, depending on how the earnest money was paid, it will be applied towards closing costs or down payment.

In cases where the buyer secures a loan with no down payment, the earnest money will just be applied to closing costs. The surplus will be paid back to the buyer. In cases where the earnest money deposit is not paid in cash and instead using other assets such as a watch, car, boat, real estate, etc., it might be returned to the buyer or liquidated and then applied to closing costs and down payment.

Here is an article on escrow money at closing.

Get Help With an Earnest Money Contract

Do you have any questions about an earnest money contract and want to speak to an expert? Post a project today on ContractsCounsel and receive bids from real estate lawyers who specialize in contracts.