Cleveland Home Buyer and Seller Education Series: Show me the earnest money
If you are purchasing a home in the Greater Cleveland Ohio area, the topic of earnest money is a topic that is not well understood by many first-time home buyers. Since earnest money is real skin in the game for a buyer, it's important that a Cleveland, Ohio home buyer understand the ins and outs of earnest money.
If you are at the point of the home buying process where you are thinking about writing an offer on a home you fell in love with, you are probably filled with excitement about the prospect of owning your own home, as well as a bit of stress (remind me to tell you someday about how I almost vomited all over my REALTOR when I was a 25 year-old first-time home buyer and stressed out before writing an offer) about all the financial aspects a real estate transaction entails – but don’t worry, millions of buyers have come before you and survived, and many more will follow you. Me, I’m on my 7th home that I’ve owned in my lifetime, so it’s not as bad as it seems if this is your first time going through it, so no worries…be happy…
Rinse...Lather..Repeat
When you find the home you want to buy, there are several things you pay for out of pocket and it seems like everyone wants a piece of your money. You will write a check for an earnest money deposit, home inspection, radon inspection (optional), pest inspection, well/septic inspection (rural properties - optional), appraisal, loan application fee and first year's homeowner's insurance premium. It's enough to make you think you are getting turned upside, but it's totally normal to feel this way.
Warning: This is going to be a dry read, so if you have insomnia and need help falling asleep, this topic is for you, free of charge! Otherwise, grab a double espresso (you are seriously going to need it) and read on… Disclaimer: I am not an attorney, and this information should not be construed as legal advice. Always seek competent legal advice for all legal matters.
Q: What is earnest money?
A: Earnest Money is money provided by a buyer to a seller and held by a 3rd party to show the buyer is serious (earnest) about purchasing the home the buyer is writing an offer on.
Q: How is earnest money created?
A: Typically, the buyer writes a personal check.
Q: How much money is needed?
A: In our local market in Greater Cleveland, Ohio, the amount is typically 1% of the purchase price. Some sellers of higher priced properties may ask for more and even upwards of 5%. In some major metro areas around the country, 5% can be the norm.
Q: When is earnest money deposited?
A: Language in the purchase agreement specific when earnest money needs to be deposited. In Greater Cleveland, the latest (3/2010) Northeast Ohio Real Estate Exchange (NEOHREX) standard purchase agreement states it will be redeemed immediately upon receipt of a binding agreement. Note: Each real estate brokerage may use a brokerage-specific specific purchase with different earnest money language agreement. This means the check is not deposited when the purchase offer is written. It is only deposited after an agreement is reached, subject to the language within the purchase agreement.
Q: Who holds the earnest money? (<;---hopefully not this guy)
A: Language in the purchase agreement determines who holds the earnest money. In a typical residential real estate purchase agreement in Greater Cleveland, it is common for the real estate brokerage representing the buyer to hold the earnest money. That said, the listing broker can hold the earnest money (sometimes common for foreclosed properties), the builder can hold it (common for new construction) and even the title/escrow company (which functions as an independent, neutral party to carry out the terms of the purchase agreement) can hold it – which is becoming more common. If a real estate brokerage holds the earnest money, a separate and special non-interest bearing trust account is required to be used, a separate ledger is required to be kept, and monies can never be placed in a brokerage’s general operating account and never used for any purpose other than as specified in the purchase agreement.
Q: Is earnest money required?
A: In Ohio, No. However, I have never sold a property where it has not been a part of the purchase agreement, so it is a common norm for virtually most or all purchase agreements when purchasing residential real estate in Greater Cleveland. See question #11 on the Ohio Association of REALTORS (OAR) website regarding contracts to purchase.
Q: What happens to the earnest money if the transaction closes?
A: It gets credited to the purchase price. In theory, if the buyer took out 100% financing and the seller paid 100% of the buyer’s closing costs, the money would be refunded at closing. If the transaction does not close, things get more complicated…read on…
Q: What happens to the earnest money if the transaction falls apart?
A: It the purchase agreement falls apart (ie. becomes null and void), then how the earnest money gets disposed of depends on what the buyer and seller agree to in writing within the context of the Ohio Revised Code (ORC) laws. In short, as this is a complicated topic, both the seller and buyer have to agree in writing how the money is disposed of. In general, the buyer should receive the earnest money back if the transaction did not close through no fault of the buyer, with both parties agreeing in writing to its disposition. If the seller’s view is that the buyer breached the contract, then the seller should keep the earnest money – but again, that only happens if both parties agree to its disposition in writing. Nothing can occur immediately without written permission from both the buyer and seller. Many purchase agreements have language that if the buyer cannot obtain financing, or material and/or latent issues arise from the various inspections, then the buyer should be entitled to receive the earnest money back – but again, only if both the buyer and seller agree in writing. Important: Neither real estate broker, nor the individual real estate agents decide what happens to the earnest money, as this is an area of law and attorneys, not real estate brokers and agents. Read on for the 2-year rule explanation that took effect on 4/7/2009…
Q: Okay, what’s this “two-year rule” I have heard about?
A: The Ohio General Assembly passed House Bill 130 with new legislation that took effect on 4/7/2009 regarding earnest money. Specifically, ORC 4735.18(A)26 was updated and ORC.4735.24 was added. In a nutshell, it says that if there is a dispute between the buyer and seller regarding the disbursement of earnest money, the broker is required to hold the funds until: a) both parties agree to its disposition in writing or b) a final court order specifies its disposition. If within two years from when the earnest money was deposited, the parties have not the broker with signed instructions or written notice that a legal action to resolve the dispute has been filed: the broker shall return the earnest money to the buyer with no further notice to the seller.
Q: What’s this thing called a “promissory note “and how does it relate to earnest money?
A: A promissory note as it relates to earnest money language in a purchase agreement is simply a promise for the buyer to pay the named entity (brokerage, title/escrow company, etc.) of the amount specified on demand. This instrument can be used in lieu of having a personal check written at the time a purchase offer is written. Once a purchase offer becomes agreed to by all parties, the buyer will write a personal check for the earnest money amount as specified in the purchase agreement.
Q: How can I get my earnest money back if the seller won’t agree in writing to give it back?
A: Small claims courts in Ohio have a maximum limit of $3,000. If the earnest money is $3,000 or less, small claims court may be the best and most cost-effective legal option. If the amount is over $3,000, then the municipal court / court of common pleas has jurisdiction. In either case, my professional opinion for all things legal, is to seek competent legal advice.
Q: Enough already...this is exciting as watching paint dry, do you have any real-life advice to share to help a buyer protect their earnest money As well as tips in general?
A: Absolutely. In no particular order:
- Understand your obligations of the purchase agreement and ensure you do not breach the contract. Understand what contingencies need to be satisfied when and ensure allied service providers perform on time. Your agent is an integral part of this. Create a list of due dates that you are required to meet.
- Surround yourself with the best people and companies in the business. Hiring the best real estate agent, mortgage loan officer, lender, title company, escrow company, and home, radon and pest inspector will go a long way to ensure your interests are well represented. Having competent and proven allied service providers is a key part of the process.
- Flushing out bullet #1 above…understanding the home inspection contingency, terms like “material” and “latent” as it relates to asking to be released from the purchase agreement. How the home inspection contingency works as it relates to removing the contingency, asking the seller for credit/repairs or last but not least, asking to be released from the agreement is paramount. You should understand this in great detail before you even enter into a purchase agreement. Note: Each purchase agreement can have different language regarding the removal of contingencies, so ensure you understand this well.
- Put down as little as possible so you have less money at risk. My goal as a buyer’s agent is to try and negotiate for the lowest amount given the unique constraints of the context (buyer’s goals, length of time on the market, desirability of property, etc.).
- Ensure the checkboxes, dollar amounts, promissory note versus check, payable to, who is receiving the earnest money, etc., language in the purchase offer is consistent and accurate.
- If a promissory note is being used, ensure it is filled out and signed properly.
- If a check is being used, ensure there are adequate funds in your checking account. Ensure it is provided to the payee within the allocated time frame specified in the purchase agreement. Write: “earnest money for: property address” in the memo field.
- Have a positive attitude and try to create a true win-win for both you and the seller. A little good will goes a long way if a transaction falls apart.
- Most of the time, most of the topics in the post never happen as most real estate transactions go smoothly, but it is good to know how things work when things don’t turn out as planned.
Most of all...take a deep breath...real estate transactions are very dynamic by nature.
Practices, laws, customs vary from state to state and even within a state, so this post is based on residential real estate practices common in Northeast Ohio / Greater Cleveland.
Read other posts in the Cleveland Home Buyer and Seller Education Series:
- Show me the earnest money
- Creating Good Will
- Closing Cost Assistance
- Documents Needed for Loan Pre-Approval
- Future Resale Implications
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