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Buying a Home: Untangling Earnest Money

Thursday, September 11, 2014

 

Photo Credit: Alaskan Dude via Compfight cc

Few things in real estate are more maligned or misunderstood than earnest money. If you’re a buyer, you have many questions and concerns: What is it?  How much should I give the seller? Will I lose it once my check is cashed?  

As a seller, you only have one question: When can I keep the buyer’s earnest money?!  

The idea of earnest money originates from England, where we get most of the basis for our existing contract law. In the 1300s, which is when the original contracts are traced from, earnest money was “consideration” given to the seller to show the capacity and seriousness of the buyer.  

Gold, horses, crops, even a first-born daughter were often used back then as earnest money.

What is earnest money today?

Today, a personal check made out to the title company (agreed upon by both the buyer and seller) will suffice. Earnest money is typically 1 to 3 percent of the purchase price of the property, though the amount is always negotiable.   

This amount varies widely, depending on the price of the house and the financial ability of the buyer. As a buyer, it also depends on whom you’re competing against for the property.  

As a seller, more earnest money expresses more serious intentions. It shows financial wherewithal and can mean less risk for the seller, which often results in the buyer’s offer being taken more seriously.   

As a buyer, if you plan to use the money for your down payment anyway, more earnest money is a simple way to communicate to the seller that you mean business.   

That being said, I don’t typically advise buyers to post earnest money above $10,000, because the limit for a small claims court dispute is $10,000. If you disagree as to whom should receive the earnest money once the transaction is terminated, and the amount is less than $10,000, neither party will have to file suit to settle the difference.

In the US, there are two different approaches to closing real estate: some states are attorney states, and others are title company states.  

Oregon is a title company state. A title company is a neutral third party that facilitates the close of the transaction. The title company holds the earnest money until the buyer decides to complete the transaction or terminate it. While the money sits in their coffers, it’s mandated by the state that no parties may earn interest on the money. The title company is instructed by the seller and buyer through the contract they provide to the title company, so the money, once deposited, is inaccessible to either party without written consent from both.

In Oregon’s real estate contract, the earnest money is fully refundable as long as the buyer terminates the contract in one of the five contingency timelines.  

Depositing earnest money can be risky. 

Buyers, that doesn’t mean depositing your money is without risk.  Life can get in the way of the best laid plans. 

I recently handled a transaction where a husband and his wife were under contract to purchase a house, and they’d exhausted all of their contingencies  (ways to get out of the contract). She took unexpectedly ill, and her husband decided he didn’t want to purchase the house. 

Because they had already exhausted their contingencies, they had no right to their earnest money. In this instance, the seller considered the circumstances and gave the buyers back their money, but the seller would have been within his rights to keep it. 

Sellers, it’s relatively difficult to retain the buyer’s earnest money, but it happens occasionally. 

If the earnest money isn’t disputed, it still doesn’t automatically come back to you. The most important rule in real estate: both parties have to agree, in writing.  That’s why communication is so very important. You and the seller will have to sign a document “releasing” the earnest money; that document will specify who gets how much. 

If there is a dispute about the earnest money, the only way it can be released is through much more complicated means: small claims court, arbitration or filing suit.

Once you decide you’re actually going to purchase the property, the earnest money converts into a portion of your down payment at closing.

Claire Paris is a principal broker and realtor at Paris Group Realty, LLC in Portland OR.  She is passionate about helping her clients build wealth and stability through real estate. She has been practicing real estate in Portland for 10 years. Visit her online at: http://www.parisgrouprealty.com/.

 

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