Safeguard your earnest money deposit by understanding how it can be lost

There are few experiences in life more emotionally and financially painful than losing money — money you’ve saved, money you’ve worked for, and money that is supposed to set you up for buying a home. It’s called your earnest money deposit — the good faith chunk of cash that demonstrates to the seller of the home you’re hoping to buy that you already have skin in the game.

The earnest money deposit is, however, one of the most misunderstood parts of the home-buying process. It consists of anywhere from 1% to even 10% of the home’s purchase price, depending on what is customary where the home is located. Want to stand out during a bidding war? One way is to up your earnest money deposit. It’s one of the most convincing ways to call “dibs” on a house while waiting for other contingencies to be removed (inspections, loan approval, etc.).

Just because you’ve plunked down this hard-earned cash doesn’t mean the seller can use it to take a vacation in the meantime, however. It remains in an escrow account or with the title company until the sale closes. Then, if everything goes off without a hitch, that earnest money is put toward your down payment and closing costs. Sound simple and fairly safe? Not so fast. There are instances for which you can see those thousands of dollars disappear from sight, never to be seen again.

One of the best ways to risk the loss of this nest egg is to waive one or more contingencies. According to a recent article in Realtor.com, in highly competitive markets it’s becoming more and more common for buyers to waive contract contingencies regarding financing or an inspection just to make an offer stronger — more of a no-brainer for the seller — and win the bid. While it will make you a more attractive buyer, you are also placing that money in peril. In fact, the seller feels justified in keeping it because if you didn’t perform as promised (pulled out of the deal, didn’t get the loan you thought you’d qualify for, etc.) and they feel damaged. In good faith, they took their home off the market for you. In fact, they may have even gone ahead and bought another home based on this, and a domino effect can easily occur. It’s not uncommon to see more than one transaction blow up in smoke because one buyer pooped out of the deal.

Unless you’re paying cash for a house, most offers include a financing contingency. The lender guarantees that you’ll get your money back if for some reason your mortgage doesn’t go through and you’re unable to purchase the house. The inspection contingency allows you to renegotiate the price or demand repairs if serious defects are found during the inspection. If those defects seem insurmountable or you can’t come to an agreement with the seller over who will pay for them, you can bow out, take your money and run.

But if your contract doesn’t have such buyer protections and you run into trouble with the inspection, you won’t be able to get your money back if you abandon the deal. Most experts deem it unwise to waive the inspection contingency unless you’re planning on tearing the property down since major defects (like asbestos and dry rot caused by water damage or termites) can be found in hidden areas. Just watch a few HGTV renovation shows, and you’ll get an idea.

Based on solid pre-approvals, many competitive buyers will waive the mortgage-financing contingency as a way to edge out all-cash buyers. But their certainty about getting that loan has to be air-tight. Ask your loan officer about a conditional approval before signing a non-contingent contract. This specifies that if the bank that pre-approved you changes its mind or does not honor its original terms, you are not out your earnest money deposit.

There is more than one way to see those dollars fly out the door. You can drag your feet, failing to honor specific time frames for financing and home inspections. As long as you’ve made a good-faith effort to adhere to the timeline, however, in most cases, sellers will grant a reasonable extension if a lender drags his feet or there are other extenuating circumstances that cause delays.

One thing to watch out for, however, is a “time is of the essence” clause in the contract. It means the closing date for the sale is binding. If you can’t make it to close for any reason, you’ve breached the contract and could lose your deposit. This is common in new home sales contracts especially, since the builder is on the hook, carrying the house if you don’t close on time, and they have their money tied up in building the homes next to it.

If none of these issues raise their heads and the only reason you want to terminate the sale is because you have cold feet, however, (this can happen when buyers find another house they like better while in escrow or they just freeze up in fear over the purchase) you likely will not get your money back.

Bottom line: the earnest money deposit serves a protection for the sellers when they take their home off the market. Your inability to perform as agreed means your money is now theirs. Simply best not to go there.

Source: TBWS

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