Preface:
The topic of Earnest Money is one of those nebulous real estate terms that few consumers (and many Realtors) have solid understanding about.
This discussion hopefully will open up a dialog for buyers and sellers to gain a better understanding of the term and the concepts involved with respect to how it is handled.
Definitions of concepts in Earnest Money:
In order for a legal contract to be binding and enforceable, there has to be "Consideration". In short that means that money has to be exchanged for something.
An example of the simplest contract with consideration:
"Albert" gives "Betty", $1(consideration) in exchange for a bucket of water. That is a Contract.
In the simplest discussion there are no expectations that the bucket of water is anything other than a bucket full of water.
Conditions and Contingencies
But what if Albert stated to Betty, that "the bucket of water needs to be clean, drinkable water"?
Now we have introduced a Condition of the purchase in order for the contract and deal to be settled.
Now if Albert didn't think Betty knew for a fact that the water was clean drinkable, Albert could add a contingency to his offer, so that the water had to be tested to verify the condition before "Albert" would agree to pay "Betty" the $1.
Now upon hearing that Albert wanted to make such a "contingency", Betty could conclude that Albert was just wasting her time and not really serious about buying the bucket of water.
This could pose a dilemma for Albert.
Earnest Money
As a way to show Betty that he truly is serious and intends to buy the water, Albert could agree to offer Betty an immediately smaller consideration as Earnest Money (perhaps .10 cents) until the water can be tested and certified as clean and drinkable.
- Albert would give the .10 cents on the condition that if the water was proven to be "unclean, or undrinkable", he would get it back from Betty and the deal would be off.
- However, If the test revealed that the water was in fact clean and drinkable, than the deal would be valid and the deal could be completed or settled.
In the case of a contract for the purchase of a home, there are usually many complex contingencies and duties that each party has to perform before the deal can be completed.
Fulfilling these obligations takes some amount of time and because of that, the two parties need to put up some good faith gesture that they are working towards the final goal.
A Home Buyer puts up the Earnest Money to demonstrate to the seller that they are serious about the offer and are not trying to waste the seller's time and efforts.
In exchange for the Earnest Money, the seller agrees to work exclusively with the buyer in furtherance of the agreed terms of the contract. Even if the seller gets another offer, the current contract is the one they are committed to fulfilling.
Earnest Money is essentially the interim tentative "consideration", until all of the terms of the contract can be fulfilled by the principal parties involved. At that time, the remaining balance of the contract is due and the contract is "settled" when everyone is satisfied.
The next blog articles will discuss:
102 Historical Context of Earnest Money
103 The Courts, Laws and changes in Martket Expectations
104 Local Market Expectations and Potential Pitfalls/Risks
105 What happens to Earnest Money in successful transactions and Unsuccessful Transactions
LEGAL DISCLAIMER: Dan Bouchard is NOT an attorney. The information contained in the article above is based on his extensive experience and knowledge of MD/DC/VA law, and ethics in the Greater Washington DC and Northern Virginia market areas, over many years in the real estate industry.
Any individuals desiring specific guidance on earnest money should contact their own legal counsel regarding their specific circumstances. This article is intended to provide an introductory concept discussion, not to provide specific guidance on what should or should not be done in any given circumstance.
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