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Earnest Money 102: Historical Context and Today's Earnest Money

By
Real Estate Agent with DanSellsDCVA RE/MAX 100

History:

Earnest Money, years ago was a major part and process of buying a home, It was a scary concept with a great deal of risk associated with it. In those days it was not uncommon to require 5-10-15% of a purchase price as Earnest Money Deposit!

In the early days, a prospective home buyer who defaulted on a home purchase contract could lose substantial amount of money because of their default

In those days before consumer protection laws were more specifically defined, and before the courts began significantly eroding the circumstances that Earnest Money could be seized by a defaulted party, the concept was daunting but was accepted as a required facet to the practice of buying and selling homes.

The intended purpose of Earnest Money then and now was/is to ensure that the buyer is serious about their offer and fully intends to perform and satisfy the terms of the contract in order to acquire the property per the terms of the contract.

Therefore then as well as now, home buyers need to take extremely seriously their intentions when making a home purchase offer and including the required earnest money that goes with it.

 

Today's Earnest Money:

Today the concept is still an important factor. But the laws and courts have drastically changed the manner and circumstances in which Earnest Money gets liquidated after a contract default by one or both parties in the transaction.

Home Buyers will be required to produce Earnest Money when they are preparing and negotiating an offer to buy a prospective home.

In the high demand neighborhoods of DC, Virginia and Maryland suburbs it is not uncommon for buyers to be expected to present 3-4% of the offer price as Earnest Money when the offer is being prepared.

In some of the less affluent areas, of DC, MD, or VA it could be acceptable to offer .5-1% of the purchase price. The presumption there being that less affluent buyers will have less resource to liquidity to make such proposals.

Usually, a personal check can suffice, but some circumstances could require certified bank funds as necessary.

In most cases a Buyer will make the check payable to the brokerage of their Designated Buyer's Agent, or perhaps to the Listing Brokerage instead. At times it may be necessary to make the deposit with a Title or Escrow company. (see my later discussion in subsequent articles on this topic regarding the risks).

 

Federal, State, and Municipal Laws

Almost every jusrisdiction in the country has some kind of legal structure that determines how Earnest Money is managed.

Some jurisdictions allow for money to be placed in accounts managed by Real Estate Brokerage Companies, others by Title Companies and still others by third party providers.

Various jurisdictions establish laws about how that money can be handled internally within an organization as well as to how the funds are to be released when called for.

Some of these jurisdictions require that funds be held in interest bearing or non-interest bearing accounts while others require that these funds can be deposited in either, so long as full and accurate disclosure is made in advance.

Usually Earnest Money deposited into an interest bearing account is payable to the benefit of the buyer however.

Contract Provisions:

Usually there are provisions in a Home Re-sale contract that will stipulate under what circumstances the funds can be released in the event that the contract fails for any reason or default by either party.

In the Greater Washington DC Area including Maryland and Virginia Suburbs, the standard Realtor Board Contracts, provide very clear guidance and direction on these terms.

Should a contract for purchase of a home, fail for any number of reasons the sales contract provides pretty strong guidance as to how the Earnest Money is to be handled.

In general however, there are only 3 ways in which Earnest Money can be released from escrow once deposited for a ratified sales contract:

  1. Successful completion and satisfaction of the contract wherein the Earnest Money funds convert into closing cost or downpayment funds and are applied to the transaction math as detailed in the final HUD-1 Settlement Statement.
  2. Upon the failure or termination of a home sale contract, the buyer and seller agree in writting to the disposition of the Earnest Money. Typically these written agreements result in either:
    • All the funds get returned to the buyer (when the buyer is not in default, and a contingency provision allows)
    • All the funds get returned to the seller (in the event of a buyer default on the terms of the contract.
    • Or some mutual agreement between the buyer and seller calling for a division of those funds to the various parties.
  3. In the event that the two parties are not able to come to an agreement as to the disposition of the funds, THE ONLY other way the funds can be released out of Escrow is for one of the following scenarios to take place:
    • One Party sues the other Party in court and the funds release is directed by the court
    • The parties proceed to a third party arbitration council
    • The Escrow agent holding the funds can file an "Interpleder" with the court so that a judge can render a decision as to the liquidation of the funds.

WHEN A CONTRACT FAILS, EARNEST MONEY IS NOT AUTOMATICALLY RELEASED!

In the absence of one of these solutions above, funds in escrow usually stay there, indefinitely inaccessible by either party.

So be sure about what you are intending to offer in your purchase contract and be sure you understand the potential risk of the loss of your funds should there be a default in the transaction by either party

There is no legal requirement mandating how much is sufficient or not. Rather local customs and seller flexibility will determine what is acceptable to them under the circumstances.

Rest assured though that the higher your Earnest Money Deposit is, the more seriously a seller will consider your offer and give it the weight it deserves.

A low Earnest Money Deposit may very well demonstrate to the seller that a buyer just isn't all that serious or intent on exercising good faith into the transaction.

Other articles in this discussion series discuss:

Earnest Money 101: A simplistic Discussion for a Comprehensive Understanding

102 Historical Context of Earnest Money

103 The Courts, Laws and changes in Market 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 containied in the article above is based on his extensive experience and knowlege 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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I am eager to speak to any prospective DC/VA/MD home buyers or sellers. dan@DanSellsDCVA.com

A. Daniel Bouchard    Service, Results, Integrity you can COUNT On!     www.DanSellsDCVA.com

   

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