Earnest money is the deposit money that you place into an escrow account when you are purchasing a property. Earnest money deposits are always made according to the real estate contract that has been drawn up and signed by all of the parties in the transaction. For example, an earnest money agreement between the buyer and the seller of the property may state that the buyer is required to place $1,000 in earnest money as an initial down payment when the contract is signed and then another 5% of the purchase price within 1 week of signing the contract. All of the earnest money deposits that are made during the real estate transaction are applied to the down payment and/or the closing costs, so earnest money deposits are not extra costs to the buyer but rather upfront payment of costs. The initial earnest money deposit is also known as a good faith deposit because it shows “good faith” that the buyer truly intends to go through with the real estate transaction.
Whether or not earnest money payments are refundable depends on the real estate contract itself. If properly negotiated, a contract will call for all earnest money deposits to be returned if the terms of the contract are not fulfilled. For example, a real estate contract for a purchase usually has a stipulation that states that the buyer must apply and be approved for mortgage financing within a certain amount of time. If the buyer applies for a mortgage but is denied financing then the earnest money deposit can be returned to the buyer. As well, a contract might state that the seller has marketable title. If a title search reveals that the seller doesn’t, then the earnest money can be refunded. Watch out though. It is not uncommon for contracts to explicitly state that there will be no refund of earnest money under any condition. This is why it is so important to have a real estate attorney draw up a contract or to fully understand the terms of the contract.
Even if earnest money must be refunded, don’t be surprised if it is less than the amount of the deposits that have been made. Often, third party fees are paid out of earnest money deposits. For example, if an appraisal has been completed on the property then the appraisal fee is going to have to be paid before money can be released to either of the parties. As well, many states have laws requiring the buyer and the seller to agree on the disbursement of these funds before they are refunded, which can lead to further problems and legal action, diminishing the value of the refund by the time and money spent on legal wrangling. Depending on the reason for the refund of the earnest money, it may be better just to walk away and forfeit the deposits.