Earnest Money Myths

said on November 4th, 2010 filed under: Information for Buyers, Information for Sellers

As a rule, I think that the contracts used in real estate today are pretty balanced. Meaning, they offer protections for both Buyers and Sellers. However, if you practice real estate in Maryland/Virginia/DC and are prone to using the Regional Contract (most of us close to DC are so inclined), there are a couple of soft spots that need pointing out. One of them is the earnest money deposit. The truth is, the contract language is written in such a way that it can be very difficult for a seller to have access to the earnest money deposit, if at all, should the buyer default.

When a buyer defaults (which means, they don’t show up to settlement to finalize the purchase of the property), the Seller has few options. As a seller, you can:

Wait it out and hope that things pull together so that the house can be sold.
Declare the Buyer to be in default, the contract void, and request the release of the earnest money deposit.

Option 1 is preferable, as long as it doesn’t injure too many people along the way. Having to put your house back on the market after a long escrow period (the time between the ratified offer and getting to settlement) can put you at a real disadvantage, both in terms of timing (think Spring market vs. Winter market) and loss of value (re-marketed homes rarely get as much money as they did the first time around). If you have some flexibility, I generally favor this approach.

Let’s say that your gut tells you that there is no way in hell that this delayed transaction is ever going to make it to closing. What to do? Well, you probably have to exercise option 2. Declaring the buyer to be in default and the contract void are pretty easy to do. Requesting the release of the earnest money deposit is a different story.

In order to have access to the earnest deposit, both parties must sign a Release Agreement (Form #1317). This form essentially releases all parties from liability, and allows the seller to sell the property to another party. There are two parts to this form. You can opt to distribute the earnest deposit to any of 4 parties (Buyer, Seller, Listing Broker or Selling Broker), or you can agree that the contract is dead and that neither party will seek performance by the other party.

Not much of a choice, huh? Here’s where it gets tricky. The house cannot be re-marketed until this form has been signed. This gives the buyer ALL of the power. The earnest deposit that was submitted as a sign of good faith no longer functions as was intended.

The truth is that the escrow deposit is a bit of a sham. It makes Sellers feel reassured, and in 99% of the transactions that go to settlement without a hitch, this is a good thing. However, as a Seller, if you need to move on from a botched sale, while you certainly will have a crack at the funds, in all likelihood you will usually forfeit the deposit. Score one for the buyers.

Well then, you ask, what’s the point of an earnest money deposit? Good question. For now, the one useful purpose it serves is to keep the money out of the hands of the buyers so that it doesn’t get spent prior to purchase (possibly interfering with their financing). Small comfort.

Now, after all of this huffing an puffing, I should mention that there is always the option of suing the other party for non-performance. But wouldn’t it be better if the contract simply dealt with this issue in a fair and reasonable manner from the get go?! Lawyers are expensive.

Be sure to check out my upcoming blog/rant about the holes one can find in the Finance Contingency. Ugh.

posted by Marcie Sandalow

This entry was posted on Thursday, November 4th, 2010 at 7:02 am and is filed under Information for Buyers, Information for Sellers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.