We all know that the earnest money deposit is there to reassure the seller that a buyer is serious about purchasing a property. But what if the buyer takes a powder, or his financials fall through? Can the seller get fairly compensated for the time her property was off the market?
Here’s everything a home seller needs to know about an earnest money deposit, and how to keep the funds if a sale goes south.
Know how much earnest money is enough
The amount of an earnest money deposit can vary wildly.
“As a broker, I’ve had buyers offer as little as $100 and as much as the full purchase price,” says Bruce Ailion, an attorney and Realtor® with Re/Max in Atlanta. This makes determining the actual figure of an earnest money deposit that works for both buyer and seller a negotiation within the overall negotiation of the sale. While buyers will generally want to part with as little as possible to limit their potential loss, a seller needs to ensure the deposit reflects the buyer’s commitment to close on the property.
Earnest money is typically between 1% and 2% of the purchase price, but it can go as high as 10%. Since this money will serve as monetary damage if the buyer breaches the contract and fails to close, the seller must also carefully consider what amount would adequately compensate for the lost time in selling the home. Be reasonable—too high a figure could scare away potential buyers.
Cash the earnest money deposit
Often an earnest money deposit is a check held by a seller’s Realtor in good faith, but it’s not cashed.
“One way sellers can protect themselves from buyers pulling out of a contract is to require that their agent actually cashes the check,” says Brian Davis, co-founder at SparkRental.com.
Granted, this cash will remain in escrow until the deal either closes or falls apart. If the latter happens, this move will prevent the buyer from cleaning out the account the check is written from.
Know your contingencies
Contract contingencies provide myriad ways for a buyer to legally back out of a sale. A seller needs to scrutinize and minimize every buyer “back door” and close any that they can, says Davis. That means if a buyer simply gets cold feet, he can’t use a contingency as a way to worm out of a contract. If you’re selling in a hot market, you might even ask the buyer to waive certain contingencies. Typical contingencies include the following:
- Funding: A buyer gets his earnest money deposit back if his mortgage falls through.
- Condition: If undisclosed problems with the property are discovered by a home inspection, the buyer can generally back out with no penalty.
- Title search: A buyer can usually void a contract if a title search comes back with a lien or issues with the ownership of a property. Sellers can do a title search before listing to clear up any red flags.
- Appraisal: When a property doesn’t appraise for the sale price, a buyer can walk away. Work with your Realtor to price your home appropriately.
Remember, if the contingencies in a sales contract are fulfilled and the buyer still doesn’t close, the seller is entitled to keep the buyer’s earnest money.
Keep an eye on contingency time frames
With every contract, contingencies must be met by the buyer and the seller within specific time frames, says Tania Matthews, a real estate agent with Keller Williams Classic III Realty in central Florida.
If one party fails to complete the required action within that time frame, that party has defaulted, according to the contract. For instance, a buyer might have 17 days to complete an inspection. If the buyer fails to do so, the seller may be able to keep the earnest money. (Just keep in mind that this cuts both ways—so the seller should pay special attention to the time limits, too.)
A seller can also add a “time is of the essence” clause into the purchase agreement. This means the closing date for the sale is binding. If the buyer can’t close for any reason, the contract is breached and the seller can keep the earnest money deposit.