Earnest Money: Eliminating Conflict and Crafting Useful Contingencies

Earnest money is a frequent sticking point when a contract falls through. Buyers want to know if they’ll get it back, and sellers want to know they can keep it as compensation for time lost. Agents are stuck in the middle. So how do you reduce the number of conflicts that arise with earnest money?

Whether you’re a buyer’s or seller’s agent, be very clear when explaining the purpose of earnest money. For buyers, the purpose is to demonstrate to sellers that they’re serious about moving forward with the contract. For sellers, the purpose is to protect them from time lost if the buyer pulls out of the contract without good cause.

Be proactive and protect your client’s best interests by addressing contract contingencies early and often.

Spend Time on the Contract

Spend extra time ensuring your client understands how different outcomes can influence earnest money. Ask them multiple times throughout the process if they understand the contract as it pertains to earnest money. If there’s uncertainty, discuss with them how these issues should be handled and if entering a contract at that time is the best choice.

Sellers may be inclined to take the offer with the largest earnest money deposit. However, it’s not always the largest deposit that’s most likely to close, and weighing the overall quality of the offer is best for all parties involved.

Buyers are often anxious to make an offer and get under contract. It’s essential to spend extra time ensuring they’re fully aware of their rights and responsibilities.

There’s also no escaping this industry fact of life: Deals fall apart. That means it’s imperative to keep up on deadlines and contingencies. Explain to your buyer what’s required to remove a contingency and provide several examples. Detail-oriented agents might even want to provide a calendar or list of contingency dates for both the agent and buyer to stick on the fridge. If your buyer is certain they’ll be withdrawing from the contract, don’t wait until the last day of the contingency to notify the seller’s agent.

Although some contingencies vary from state-to-state, there are a handful that you will see repeatedly.

Appraisal Contingency

A lender will require an appraisal as a condition of financing. The purpose of the appraisal is to compare the appraised value of the home to the purchase price. This is done to protect the lender from risky investments. If an appraisal comes in lower than the purchase price, the lender will require the buyer to make up the difference in cash, reduce the contract price or walk away from the deal.

Some consumers – often cash buyers or those with significant assets – choose to waive the appraisal contingency and agree to move forward with the purchase regardless of the appraised value. Waiver of this contingency should not be taken lightly. Buyers unable to move forward could lose their earnest money and even face legal action.

Financing Contingency

Cash buyers accounted for 42 percent of all residential purchases in December 2013, according to RealtyTrac. The rest are relying on lender financing.

Prepared buyers will submit a preapproval letter with their offer demonstrating they’ve contacted a lender and have provided income and asset information to their loan officer. But preapproval doesn’t guarantee loan approval. There are circumstances when a buyer who has been preapproved is unable to obtain final loan approval. This is often due to an issue that arises when underwriting the loan.

Contingent on Selling Current Home

This contingency is less prevalent in competitive markets. But in others it’s given serious consideration. This contingency will typically cite a specific number of days the buyer has to sell their current home. Once the deadline is up, the buyer can withdraw the contract or agree to move forward with the purchase without regard to whether their current home sells. This contingency may also contain a provision that allows the seller to accept back-up offers while the contingency is pending.

Contingent on Inspections

There are numerous inspections a homebuyer can request. Some of the most frequent include a whole home, roof, pest, sewer or well inspections. Home inspectors will inspect the home down to the most minute details with an expert eye. They can also provide estimates on remaining life in certain appliances and heating/cooling mechanisms. Even though home inspections are not typically required, it’s highly recommended that all buyers spend the money to obtain one.

Other inspections are dependent on the home and the lender. The additional inspections should also be waived with caution. It’s important to note here that you should check with the buyer’s lender regarding whether they have any required contract contingencies or inspections that you need to cover. Some may require a pest inspection on all properties, while others will have more relaxed standards.

By understanding and explaining the purpose of earnest money and the contingencies tied to its release, you can save your clients unnecessary headache if trouble arises with the contract.

If you have any questions about real estate or the VA loan, please don’t hesitate to email me at samantha@vu.com.

Photo courtesy The Lamb Family