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Understanding Earnest Money During a Real Estate Transaction: Chadwick's REAL Tips Episode 14

Whether you are buying or selling a home, you might need to understand all the caveats pertaining to earnest money!

We are honored to have Cindy Cogan, Senior Escrow Officer and Branch Manager with Heritage Title, explain to buyer and sellers how Earnest Money works during a transaction. It can be a bit more complicated than a buyer or seller would think. Be sure to avoid some awkward situations and read our important tips:

1. What is earnest money?

Earnest money is a "deposit" that the seller requires along with the buyer's offer to demonstrate how "earnest" the buyer is. In other words, it demonstrates the good faith on behalf of the buyer. In most transactions, the buyer issues a check for the amount of earnest money stated in the listing. However, in a strong sellers market with sellers receiving multiple offers, a buyer may put down more earnest money to make their offer look more appealing.

2. Where does my earnest money go after I deposit it? Is it used towards the purchase of my new home?

Earnest money is placed in a "escrow account" and the location of that account is typically chosen by the seller. An escrow account is like a separate bank account exclusively supporting the transaction of a home sale. In most cases, an escrow account will be held with a Title Company; however, some large brokerage firms have the ability to provide their own in house escrow accounts for the sole purpose of holding earnest money. The contract to buy and sell dictates where the money should be deposited. Lastly, the amount of the earnest money is deducted off of the top of the purchase price. It is like a small prepayment of the home. You will see this line item on the "Settlement Statement" at closing.

3. Your Title Company is a third, neutral party!

Since the seller typically chooses the title company in the contract to buy and sell, it can be often misperceived by buyers to think that the title company represents the seller. The title company must be a third, neutral party. In a nutshell, their job is to make sure that all bills and debts are paid, financing (whether a home loan or cash) has arrived, and that the title of the home is transferred from the seller to buyer free and clear of any liens and encumbrances. It would be safe of think of the title company as the neutral person who monitors all the "checks and balances" during a real estate transaction.

4. What happens if the buyer or seller falls out of contract? Who gets the earnest money?

This is one of the most contested issues in real estate transactions and can be very unique to the given situation. Remember, earnest money is well outlined in the contract to buy and sell. However, here is our attempt to simplify the concept so that it is easier to understand. The buyer has many opportunities to fall out of contract and be entitled to their earnest money. They are referred to as "objection and/or resolution" deadlines. Think of these like an "exit door" for the buyer. Should the buyer not agree to specific terms unique to that deadline, the buyer will by default be entitled to their earnest money. Take for example the inspection objection deadline. The buyer submits a long list of items that they want the seller to repair. The seller then submits an inspection resolution, but only offers to repair a small portion of the items. The buyer can choose to accept the sellers resolution, forfeit their right to earnest money for this specific objection, and continue further down the transaction OR not accept the seller's resolution and fall out of contract (in which case the buyer would be entitled to their earnest money).

If the buyer defaults or misses a deadline and gets cold feet later on in the transaction, the seller may very well be allowed to keep the buyers earnest money. There are many different scenarios and thus is it important that you are in constant communication with your Realtor.

In situations where both the buyer and seller feel entitled to the earnest money, the contract to buy and sell requires both buyer and seller to first go through mediation before entering a legal dispute.

5. How does the Title Company release the earnest money?

For any release of earnest money, the Title Company MUST receive a Mutually Executed Release of Earnest Money. This means that both parties (buyer and seller) sign in agreement to release the earnest money. The title company will not favor any side of the transaction - they can't. Remember that they are a neutral, third party!

Issues with earnest money can be resolved very quickly when reviewing the contract to buy and sell. The contract specifically lays out guidelines that both the buyer and seller must follow. For further questions, be sure to reach out to your Realtor who is representing you.

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