What is Earnest money and when is earnest money refundable?

What is Earnest money?

The earnest money deposit is a deposit paid by the buyer when the buyer enters into an offer to purchase and contract to buy a certain piece of real property. The amount of the Earnest Money Deposit typically ranges from one to two percent of the purchase price. This deposit is for the benefit of the seller and helps the seller to know that the buyer is “earnest” about purchasing their property.

As the buyer’s attorney, we often suggest that the Earnest Money Deposit be as low as the seller will accept, however in today’s competitive real estate market, Sellers find a higher EMD to be more enticing and will increase the chances that the Seller accepts your offer instead of the others that he or she receives. The question we most often get is whether the EMD is refundable and when can the buyer get it back?

When is the Earnest Money Refundable? 

Real estate agents often use model contracts that are approved by the North Carolina real estate commission such as the form to T which is the standard offer to purchase and contract. In most Offer to Purchase and Contract agreements, it is usually stated that the Earnest Money Deposit is refundable to the Buyer if either

  1. the offer is rejected by the Seller; or
  2. a contract between the Buyer and Seller is not fulfilled by the Seller

Financing Contingency

Naturally, there a possible exceptions to every rule. the standard form 2-t or offer to purchase and contract does have a space for the parties to elect exceptions to the general rules about the earnest money deposit. For example; there is a box that could be checked that says the earnest money deposit is conditional upon the buyer being able to obtain or close a loan for the purchase of this property. This is known as a financing contingency.

A financing contingency is a clause in a contract that states that the Buyer’s offer relies on the Buyer actually getting the necessary financing before the contract becomes binding. In other words, a financing contingency’s inclusion in an Offer to Purchase and Contract means that the Buyer has time to secure a loan and if he or she is not able to, the contract becomes void and does not have any legal consequences. The inclusion of a financing contingency in the contract protects the Buyer in the event that they are unable to get the necessary financing to complete the purchase.

While a seller often rejects offers to purchase, because they get so many, it is extremely rare that once the contract is signed the seller would pull out of the offer to purchase and contract because they would be in breach of the contract and the buyer can sue them to enforce the sale. It is also possible that the seller is unable to deliver title to the land, which means they cannot fulfill the agreement. In this case the earnest money deposit is refundable. These are few and far between however.

How Can the Buyer Protect His Earnest Money Deposit?

There are very few ways for a potential buyer to protect his earnest money deposit. When entering into the contract be sure to consult an attorney to find out what sort of exceptions can be built in on the earnest money deposit.

Considering a financing contingency is also a smart decision. Aside from that the buyer really should focus on due diligence and getting all the necessary inspections and title work as quickly as possible. In that situation the buyer has gathered information that he needs so that he or she may make the decision as to whether or not to pull out of the contract before the due diligence date, thus saving their earnest money deposit.

If a buyer decides, before closing but AFTER the end of the due diligence period, that they no longer want to move forward with the purchase of the home, they can walk away but will lose both their earnest money and due diligence money.

The bottom line is that the Earnest Money Deposit is generally not refundable, but they are some exceptions. Before signing the contract, it is important to discuss the risks of an EMD with your attorney. If you sign the contract, as your due diligence period approaches, be sure to consult with your attorney about risks involved with this closing, including your financing, and consider whether or not you should pull out of the purchase.

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