What Exactly is an Earnest Money Agreement?
An earnest money agreement is a contract between a potential buyer and seller of a piece of real property. In any standard purchase and sale agreement for real property, you will likely see a line item for a deposit from the buyer. This is known as an earnest money deposit. An earnest money agreement can specify the amount of this deposit, but will typically include the following contract terms:
• Buyers Name
• Seller’s Name (the seller may be a trustee, bank, a managing firm or investment group in an investment purchase)
• Date of Estimate Completion of the Agreement
• Subject Property Address
• Applicable Dates such as: Offer Acceptance, Closing and Financial Conditions
• Contractual Conditions such as: Financing, Occupancy Issues, Approvals by Third Parties, Title Issues
• Contingencies
• Financial Terms such as: Financing, Paying the Deposit, Balance of Sales Price to be Paid, Amounts to be Held in Escrow
• Depositing and Managing the Earnest Money
• Materials and Facilities (if applicable the agreement may call for the developer of a large subdivision to include the purchase of a lot and the utility of builder materials from the company’s facility)
• Covenants (Obligations) of the parties
• Conduct during and after the term of the agreement
• Adverse legal action against the property by civil authorities such as a condemnation suit
• Dissolution of Ownership (in the event of bankruptcy by either party)
• Scope of Work (including impact fees and permitting)
• Insurance Requirements
• Applicable Law (usually the state in which the property is situated)
• Failure to Perform (such as a requisite to build or finish building the house or other improvements on the property)
• Agreements that Apply to the Property
• Disputes (usually a procedure to avoid litigation filing through mediation or arbitration)
• Signatures of the parties (the parties may be one individual or two parties such as: husband and wife, LLC, Trust etc . )
A seller will use an earnest money agreement to ensure that they are fairly compensated for the sale of the property. However, it has become customary for an earnest money agreement to contain contingencies to aid the buyer in getting the best deal with the least amount of liability. The benefit to the buyer is that if the deal does not work out, the buyer will get all of the earnest money back. If the deal does go through then everyone wins.
The importance of an earnest money agreement is they provide a secured contract where every party knows their rights and obligations. If a buyer is serious about buying a home or other property, an earnest money agreement will demonstrate this to the owner.
Essential Components of an Earnest Money Agreement
An earnest money agreement is generally a simple contract, but it should include certain key elements. While state laws give general guidance on real estate contracts and earnest money agreements, especially when dealing with mortgage granting, there is no uniform federal law applicable to earnest money.
Normally, it includes the identities of the buyer and seller and general information about the property—usually just a short legal description with the street address. It should also outline the earnest money deposit amount (usually 1 percent to 3 percent of the purchase price) and payment details. The agreement also must detail the conditions under which the buyer gets the money back (for example, if the home inspection shows serious problems) or forfeits the money (if the buyer fails to obtain financing).
Sample Earnest Money Agreement Template
Earnest Money Agreement Template
Below is an example of a well-organized earnest money contract. A prospective buyer can use the space provided in brackets to customize the contract to fit their specific transaction. In addition to the information below, the earnest money agreement can be personalized to match the terms of your purchase agreement.
Sample Earnest Money Contract:
This Earnest Money Contract ("Contract") between ________________________ ("Buyer") and ___________________________ ("Seller") is executed on the ____ day of ___________________________.
Buyer and Seller have entered into a Purchase and Sale Contract dated ___________________________ (the "Purchase Contract") for the sale and purchase of that certain real property described as follows: ___________________________ ("Property"). Buyer and Seller hereby agree that the following terms are to be part of the Purchase Contract, and all other terms, covenants, and conditions of the Purchase Contract not inconsistent herewith shall remain in full force and effect.
Buyer shall deposit with Escrow Agent as part of the Purchase Price, the sum of $_________________ ("Earnest Money") as earnest money prior to the dates set forth in the Purchase Contract. Seller shall be entitled to the amount of the Earnest Money in the event of a default by Buyer under this Contract or under the Purchase Contract.
In the event Buyer and Seller have entered into this Contract before the Purchase Contract has been approved by Seller, then until the Purchase Contract has been approved by Seller, the obligations of the Buyer and Seller under this Contract shall be contingent upon such approval by Seller. In the event the Purchase Contract is approved by Seller, this Contract shall remain in effect. In the event the Purchase Contract is not approved by Seller, or the Purchase Contract is terminated by either Seller or Buyer in accordance with the terms and conditions contained within, then this Contract shall terminate and the Earnest Money shall be refunded by Escrow Agent to the Buyer.
Escrow Agent agrees to hold and disburse the Earnest Money according to the following hierarchy: (i) upon recordation with the office of the county recorder of the county in which the Property is located of the deed provided for in the Purchase Contract, the Buyer shall be entitled to a return of the Earnest Money less any amount owed by Buyer to Seller under the Purchase Contract; (ii) if the sale and purchase of the Property shall be prevented or terminated by default of Buyer or mutual consent, Escrow Agent shall pay the Earnest Money to Seller, and the Buyer shall have no further right with respect to the Purchase Contract, this Earnest Money Contract or the Earnest Money; and (iii) if title to the Property shall pass to Seller through foreclosure or similar action, then upon receipt of a notice thereof from Seller, the Escrow Agent shall pay the whole of the Earnest Money to Seller.
Escrow Agent shall not be required to continue to hold the Earnest Money after 30 days from the date of termination of the Purchase Contract and shall return the same to the person or persons who delivered it to the Escrow Agent and who can sign for it. The person or persons who received the Earnest Money shall hold Escrow Agent harmless and indemnify Escrow Agent against all claims for return of the Earnest Money so returned.
Buyer and Seller hereby agree to the above terms and conditions and each shall be deemed to have been represented by competent legal counsel in this transaction.
Signed this ____ day of ___________________________.
Earnest Money Agreements: Legal Implications
Earnest money agreements, while not the lengthiest contracts parties will enter into in real estate matters, are nonetheless essential pieces of any real estate transaction that should be carefully considered. While some earnest money agreements with a particular personality may not be binding, most of them – especially earnest money agreements written by real estate attorneys – will carry legal weight.
If an earnest money agreement is broken, the consequences differ depending on which party breaks the contract. If the buyer breaks the contract (usually after financing or other contingencies are not met) , the seller may keep the earnest money deposit. If the seller breaks the contract (without justification), the buyer may sue the seller for specific performance of the contract, which means that the buyer will purchase the property at the agreed price regardless of the seller’s refusal to perform. Alternatively, the buyer may seek cancellation of the contract and monetary damages if they are measurable. A cancellation of the contract typically also entails a refund by the seller of the deposit.
Common Mistakes to Avoid in Earnest Money Agreements
When transactions become contentious, earnest money agreements make for a convenient scapegoat. In fact, as attorneys, we have often cautioned clients to carefully choose how much, if any, earnest money deposit should be placed in escrow because that amount is often the only reason parties ever entered into the transaction—and they lose the "money" on which their agreement was predicated. As such, parties should consider whether it is worthwhile to enter into a purchase and sale agreement before performance or a ten-year lease for a few thousand dollars in earnest money. But the possession of earnest money is rarely the end of the story. Below are some common mistakes made when entering into earnest money agreements and how to avoid them.
One of the most common mistakes made in earnest money agreements is not intending an implied covenant. Whether it be because "time is of the essence" or there are certain contingencies in the contract, if the parties really intend for time to matter, it should be expressly stated. If the parties do not intend for there to be an implied time of the essence element, that should also be expressly stated in the earnest money agreement. Another mistake is not being clear on what is material and what is not. Often small items become deal breakers. If the parties do not intend for each small issue to be a deal breaker, that should be expressly stated. How the escrow agent is to be paid is another oft-forgotten item. Escrow agents are traditionally compensated evenly by the parties, but with a little creativity or negotiation, the parties may change that to fairer compensation systems such as paying the escrow fees from the earnest money deposit. Back to the amount, the parties should be sure to state how the disbursement of earnest money is governed if the earnest money deposit is reduced or increased (i.e., through a change order, etc.). Finally, does earnest money automatically become non-refundable once the contract is signed? If so, does it apply to earnest money already paid, or the full amount to be deposited? If this is unclear, there could be an issue over how escrow will be released in the event that it is not released by agreement.
Frequently Asked Questions About Earnest Money Agreements
As a prospective buyer or seller, it is common to have questions about the earnest money deposit or earnest money agreements and how it all works. Here are some of the most commonly asked questions:
How much earnest money is typical?
The amount of an earnest money deposit varies greatly. It can range from as low as $50 to a percent of the purchase price or even a few hundred thousand dollars or more. Generally speaking, the higher the value of the transaction, the higher the earnest money required. However, it’s usually justified in the amount of consideration for the transaction.
What happens if the transaction falls through?
In that case, the seller and buyer may be able to come to an agreement of their own regarding the return of the earnest money deposit. In other cases, the escrow company or title company must make a determination of the rightful owner of the funds based on the claimed rights of the parties, terms of any agreement, and the rights of the holders of the escrow . The escrow company will often follow directions from the seller and buyer if they agree. If they do not agree, the escrow company/agent will not be in a position to render an opinion and will often wait until they have been properly instructed in writing or by a court order.
How are earnest money agreement disputes resolved?
The dispute resolution process depends on the type of agreement that was made in the earnest money agreement or purchase agreement. If the agreement was to go through arbitration, then arbitration would occur. In some cases, the dispute is not held up by arbitration and progresses directly to state court litigation. Often, if there is a dispute, an action is commenced to quiet title and a title report is ordered and filed with the state court to determine the status of the title.
