MARIETTA, Georgia – August 8th, 2016 – A Buyer recently asked an agent if they can buy a house without paying earnest money in to escrow for the duration of the contract. This question has stuck in my head. As I look back on my career, I realize that I’ve explained, often simply, the necessity of earnest money more times than I care to count.
What is Earnest Money?
Earnest money is a way for a buyer to show seriousness with their intent to purchase a house. When a buyer places an offer to purchase a house there is always uncertainty for the seller. This uncertainty is interpreted as risk that the sale may not close. The payment of earnest money helps offset this risk to the seller. Some common reasons for the buyer to not close include:
- Buyer’s loan is denied
- Buyer backs out of the contract
- Buyer becomes unemployed
- House does not appraise
- Buyer changes mind
- Buyer improperly files their taxes
How much earnest money should be held in escrow?
This number can vary on the contract. At a minimum it should cover the risk the seller faces. If a property is vacant and sub $100,000 then a seller may find a smaller amount sufficient.
If the property is a higher value, or if the seller will have to vacate prior to closing then there will be a higher cost incurred by the seller if the property fails to close. The seller will have to cover the expense of movers, temporary housing, and the opportunity cost for seasonal market changes. I recommend that the earnest money be sufficient enough to offset some of this risk for an acceptable contract.
How does it work?
When a buyer and seller enter into a contract, the contract designates how much the buyer will pay and who will hold the earnest money. The buyer will then follow the terms of the contract to pay the earnest money. In Georgia, the funds are usually held with a real estate broker or a closing attorney. Both brokers and attorneys have strict requirements for handling earnest money. The holder of the earnest money never has a claim to the funds and therefore must keep the funds in a trust/escrow account.
When the contract closes, the broker can handle funds in one of two ways. The first way is that any commission owed to the brokerage holding the funds is reduced by the amount the broker is currently holding, then the broker may transfer their funds from the trust/escrow account to their general account. The second way is the broker can send the funds to the attorney to disburse along with the general accounting for the transaction.
If the contract does not close then the holder must disburse according to the terms of the contract. The buyer and seller often times agree where the funds should go. If there is a dispute then the job falls on the broker or attorney to reasonably interpret the contract and disburse accordingly.
While rarely needed, in some severe circumstances, court intervention is needed to resolve disagreements.
Chris Lazarus is the Principal Broker of Sellect Realty in Marietta, GA.