The earnest money deposit doesn’t guarantee that the purchase will happen or obligate the buyer to complete the purchase. It does require the selling party to take the property off the open market for a set period of time, allowing the buyer to secure financing and conduct a property appraisal and inspection. If the deal does proceed to closing, then the earnest money deposit is applied to the buyer’s portion of the closing costs or down payment.
The purchase contract will have specific language regarding the terms and the timeframe that the earnest money deposit—and the contract itself—is valid. These terms benefit both the seller and the buyer. Typical language in a home purchase agreement or sales contract will include:
- A set deadline by which the deal must be completed—the buyer must finish their due diligence on the property during this time and secure the mortgage loan. If the buyer can’t secure funding or walks away from the deal, the earnest money deposit is forfeited. These timeliness clauses and loan contingencies protect the seller from having their property sit off the market for extended periods of time. The buyer should have a pre-authorization letter from their lender to best ensure that they will secure the eventual mortgage loan.
- The estimated value of the property and a validation of its current condition. If the inspection turns up issues not mentioned in the contract and the buyer and seller can’t work out a resolution, the earnest money deposit can be returned to the buyer from the escrow account.
- The inspection turns up issues not previously disclosed that have a material effect on the property’s value. It is the responsibility of the buyer to negotiate timeliness clause deadlines for the inspection contingency that allow ample time for inspections to take place. If the buyer and seller can’t negotiate a satisfactory conclusion, the buyer can walk away from the contract with the earnest money deposit returned.
- The mortgage lender will not fund the loan, and the financing contingency has not yet passed.
- The seller decides to terminate the deal for any reason once the purchase price has been contractually agreed upon.
- The buyer discovers a material problem with the property after the timeframe has passed, and wants to walk away from the deal.
- The buyer obtains full mortgage funding, meeting the financing contingency, but then decides to walk away from the deal anyway.
- A contingency removal form is filed by the buyer specifically removing one or more of the terms of the purchase agreement, then walks away from the deal.
- If a buyer walks away from a purchase agreement or sales contract in a timely manner, most legal jurisdictions mandate that earnest money deposits be returned to them from the escrow company within 48 hours. Depending on the terms of the purchase agreement and local regulations, both the buying and selling parties may need to sign a form and send it to the escrow company before the earnest money deposit can be released.
During this time, the earnest money deposit is earning interest in the trust account where the monies are held. If interest accrues in the escrow account in an amount over $5,000, whichever party is due the earnest money will need to file Form W-9 with the IRS to obtain the accrued interest.
Learn more on BiggerPockets:
- Quit Your Day Job and Find Financial Freedom: Here’s How to Become a Real Estate Investor (Full-Time!)
- Introduction to Real Estate Investment Analysis
- 5 Steps to Successful Real Estate Accounting for Investing Newbies