Understanding Earnest Money

There are two main ways a buyer can terminate a contract without losing their earnest money in a standard Texas Real Estate Commission Option Contract.  The first pertains to the option period.  The second way is related to buyer financing.  That article will follow at a later date.

 

Earnest Money is totally different from an option fee.  The option fee is a nominal amount (we usually ask for $100 when we are representing sellers), which becomes forfeitable immediately when the contract is signed.  It is purposely kept at a low amount so as not to hurt the buyer if they decide not to buy the property during their inspections and due diligence. 

 

The earnest money is a much, much more significant amount.  When we are representing sellers, we like to see 1% in earnest money.  For example, an $800,000 home would require $8,000 in earnest money.  Its purpose is to contractually bind a buyer and seller from the time the option period expires until the property closes.  It is intended to be more painful to the buyer if they do not perform as to the terms of the contract and default.

 

 

Who Holds the Earnest Money?

 

The earnest money check is written by the buyer and typically made out to and held by a title company.  The title company acts as a third party without any special interests on either side.  However, builders and developers will often ask that the earnest money check be made out directly to them, not the title company.  Although there is some risk in this (which is explained later in this article), reputable builders and developers are not going to tarnish their reputations by withholding earnest money in bad faith. 

 

 

What Role Does The Title Company Play In The Transaction?

 

The title company is there only to help facilitate the transaction.  They represent no-one except themselves.  Even though most have attorneys on staff, they know better than to make a determination as to who is or is not in compliance with the contract or who should receive the earnest money.  They will draw the closing documents for the buyer and seller, but both parties will be asked to acknowledge in writing that the title company represents neither of them on that transaction. 

 

 

How Does The buyer get their earnest money back From the Title company?

 

Many buyers think all they have to do is notify the title company that they want to terminate the contract and the title company will give them their earnest money back.  While this is true during the option period (the due diligence and inspection period), when that time period passes, it becomes a little trickier.  During the option period, the buyer can terminate the contract for any reason whatsoever and the title company can release their earnest money to them without approval of the seller. 

 

After the option period (which usually lasts from 7 to 14 days for a home) has expired, if the buyer wants to terminate the contract and get their earnest money back, the title company will ask both the buyer and seller to sign a release of earnest money form.  Both sides must sign the release which spells out to whom the earnest money goes and in what amounts before the title company will disburse the funds. 

 

 

Who Really Deserves the Earnest Money When a contract falls apart?

 

You tell me!  Is it the seller because his buyer backed out three days before closing when they found a better deal?  Is it the buyer because his seller could not finish the construction (or repairs) to their home and forced them to buy another home?  What happens if the buyer's lender drops the ball and is not ready to close on time?  What if the buyer could not get financing?  What about a buyer who says they could not get financing but didn't really try?  You can see how this can really get messy. 

 

It was not unheard of for a seller to become so upset with the buyer that they will not sign the release of earnest money out of sheer anger.  Even though the seller knew he probably wouldn't get it, he was going to make darn sure the buyer didn't get it either (or at least he was going to make them fight for it).  And that door swung both ways. 

 

A buyer can just as easily refuse to sign a release of earnest money to the seller even if the seller was in perfect compliance with the contract and the buyer backed out of the contract illegally.  The seller may have to go to court to get the earnest money if the buyer refuses to sign the release.  This is exactly why homebuilders and developers prefer to have the earnest money made out to them, not the title company.  If problems rise along the way, they already have the earnest money sitting in their account.

 

In 2006, our standard TREC contracts were modified to stop this potential for abuse.  Language was added to this effect  ...  if one of the parties does not sign the release for the earnest money to the other party and this is done solely for malicious purposes or without merit, the party who refuses to sign the release can now be held liable for THREE times the amount of the earnest money.  I think this is going to make either side think twice about not signing a release of earnest money even though they know they breached the terms of the contract.

 

 

What Happens to the earnest money If Both the buyer and seller Refuse to sign the release?

 

 

I called one of our preferred title companies (Chicago Title) and asked John Butcher what happens under the following scenarios ...

 

  • If only one side makes a claim to the earnest money - the title company will try to contact the other side for the release.  If the other side does not respond within 15 days, the title company can release the earnest money and they will be held harmless. 

  • If neither party claims the earnest money - it remains in a non-interest bearing account with the title company for a period of three years.  After that, it goes into a state fund. 

  • If both sides want the earnest money and neither will sign the release - John said this is very rare, but the money has to remain with the title company in a non-interest bearing account until

    • either the buyer and seller work it out

    • it goes into the state fund after 3 years or

    • the issue is forced into the courts. 

 

If all else fails, the title company may try to "broker a deal" between the buyer and sellers suggesting they each take a percentage.  John reiterated that the litigation costs almost always outweigh the earnest money so it is just not worth the fight.

 

 

 

 

Tom Grisak Estate Homes Realtors, Inc - Texas License # 0329533

Your Realtors for Allentexas, Fairviewtexas, Lucastexas, McKinneytexas, Murphytexas, Parkertexas, Prospertexas