Neither buyers or sellers ever want to get into a situation where a contract falls through. There are situations, however, where it makes sense for either the buyer or seller to walk away from the transaction. When a buyer and seller have a contract that falls through, what happens to the earnest money deposit?
In This Article, You Will Learn:
- What is Earnest Money?
- What happens to the earnest money if there are still contingencies in the contract
- What happens to the earnest money if there are no contingencies left in the contract
- Other considerations when determining who gets the earnest money
First, what is earnest money?
Earnest money deposit is money that a buyer deposits (usually at the title company or at the buyer broker’s escrow account) when you get a property under contract. The buyer agrees to forfeit the money if they decide to back out of a contract. Essentially, it is showing the seller that the buyer has “skin in the game”. Without it, buyers could essentially get properties under contract and then back out with no consequences, while the seller took the property off the market and potential lost out on other buyers.
Second, are there any contingencies left in the contract?
Contingencies are put in place to allow the buyer to back out if they have a legitimate reason for not purchasing the house. Typical contingencies include home inspection, financing, and appraisal. If a buyer backs out using one of these contingencies, then the buyer gets his earnest money deposit back. When it is clear the buyer is backing out using a legitimate contingency, the seller will want to get the notice to void signed quickly, so they can move on to finding the next buyer. It is typically cases where there is a disagreement of whether a contingency still exists (and therefore a valid reason to void the contract) where you find the seller dragging their feet on releasing the earnest money deposit.
You do have to make sure you follow the contract contingency language to the letter in order to legitimately back out of the contract. For example, in the Northern Virginia Regional Sales Contract, the home inspection contingency indicates that the buyer agent must furnish a home inspection report along with the notice to void. If the buyer agent only sends along the notice to void without the home inspection report, then the notice to void may not be valid.
If there are no contingencies left and the buyer still wants to back out, then the seller has the right to demand all of the earnest money deposit.
This money takes into account the lost time and opportunity for potential buyers to come and buy the property. There is also the sigma of having a contract already fall through on the property. It puts a big question mark in the buyer’s mind of why the first buyer didn’t purchase the property. For example, I represented a seller that got a property under contract at full list price after only 5 days on market. However, the contract fell through and we had to go back on the market. All the other buyers that were previously interested already put offers on other properties and we could only get another contract that was $5,000 less than the first one. The earnest money goes towards bridging that gap between the first and second contract.
Buyers should also keep in mind that if they do not agree to release their earnest money deposit, they may be held liable for even more damages beyond their earnest money deposit.
This is particularly true if the market is turning down and the seller can not sell the property for the original sales price. For example, let’s say Seller Sally got her house under contract for $850,000 with Buyer Bill. If Bill backs out of the contract and Seller Sally can not only get $825,000 for her house, Sally may be able to go after Bill for the $25,000 difference. (Note: I’m not an attorney, so please consult a qualified real estate attorney for your specific situation.)
In general, it is the best for both buyer and seller to try work out a solution that allows the contract to move forward. By cancelling a contract, the seller has to go back out to the market with no assurances they will get the same sales price as before. For the buyer, they may have already spent hundreds of dollars on inspections and appraisals, which are only for that specific property. If the contract does fall through, however, it is best for both parties to come to an agreement on the release of the earnest money deposit as soon as possible so both parties can move on.