What Is an Earnest Money Contract?
The definition of an earnest money contract is that it is a form of a purchase and sale contract that deals with the deposit of the earnest money at the time of the offer and before acceptance of the offer and before acceptance of the buyer’s offer to buy the property, and it deals with what to do with the earnest money after it is deposited.
While some parties may execute a written contract and use a completely separate earnest money agreement to deal with the deposit and return or forfeiture of the earnest money, it is not uncommon for the parties to execute a single contract simultaneously with the deposit of the earnest money . It is most often the case that for a transaction to be binding, there must be a written contract on which to enforce the terms of the purchase and sale.
An earnest money contract merely memorializes the form of the mutual agreement between the parties that the buyer has given a certain dollar amount or other property as earnest money in connection with his or her agreement to purchase the property or both. In most states, this is the first step of the contract formation process leading to the eventual binding purchase and sale contract between the buyer and seller.
Essentials of an Earnest Money Contract
The fundamental components of an earnest money contract are the subject of this section. In addition to the purchase price and earnest money deposit, a contract will usually include the contingencies contained in connection with the property that must be satisfied before closing. Examples of these contingencies include financing requirements, home inspections, lease reformation, denser notice, homeowner association approvals, tenants and appraisals. Most contracts will expressly indicate that buyer and seller are in receipt of the contingency and what will occur if the contingency is not satisfied or satisfied.
Purchase and sale contracts will also have a provision that the closing of the transaction shall occur by or before a certain date. The close of escrow date may be extended upon agreement by both the buyer and seller. If the transaction does not close by the specified date then liquidated damages may be assessed against the party or parties responsible for the delay.
The buyer is usually required to make periodic deposits into escrow according to an agreed upon time schedule. If the buyer fails to make such payment then the deposit may not be refunded.
There will be a provision which allows a buyer’s money to be refunded if the contract is not closed by a specified date. After the necessary investigation, the buyer is required to decide whether to move forward with the transaction and have it closed. If the buyer determines that they do not wish to proceed then the earnest money will be refunded and the contract is voided.
How to Create an Earnest Money Contract in 8 Steps
While real estate transactions can be complicated, signing a real estate contract does not have to be. Whether you are the buyer or the seller, you can easily avoid many of the pitfalls when you use clear language in your contract and follow these steps:
- Reach an agreement: The first step in any contract is reaching an agreement. After negotiating the terms of your agreement with the other party, send the terms in writing for review. This is the stage where you should start involving your lawyer. If you use an agent, your agent can help you draft an earnest money contract based on the results of the negotiations.
- Create a contract: Once the terms have been solidified, you can start on the earnest money contract. You will need the full name, email address, and physical address of you and the buying party. After that, the earnest money contract will outline the property, the purchase price, the closing date, any contingencies, and any other special provisions.
- Determine the amount of earnest money: The amount of earnest money is decided by the buyer and the seller. It is usually 1-2 percent of the sale price, but it can be higher or lower. A higher amount suggests a higher level of commitment.
- Write in conditions: Even if you reach agreement, there may be factors that must be considered. Factor weather, terrain, title issues, and any other factors that may prevent closing during the negotiation phase.
- Review with an attorney: While it is possible to draft an earnest money contract on your own, it is best to review it with an attorney. Your attorney can identify problems in the language of the contract and point out provisions that may not make sense or could leave you open to liability.
Of all the contracts involved in real estate transactions, an earnest money contract is one of the most important. Because it can dictate whether you move forward with negotiations, having a robust agreement is vital.
Common Pitfalls (and Their Solutions)
A frequent misunderstanding occurs when a seller feels compelled to sign a seller disclosure form to satisfy the buyer’s obligation (i.e., as a condition precedent, or condition that must be completed before something else can happen) to receive a copy of the executed earnest money contract. Alternatively, in an effort to be good sellers, some sellers complete a seller disclosure form without actually knowing if it is accurate, intending to follow up with correcting the inaccuracies after they sign the earnest contract.
Ultimately, it is the buyer that is responsible for returning a signed copy of the earnest contract to the seller, so if this is not done for any reason, it can be remedied by the buyer requesting a copy from the seller. Never the less, it is best practice to not delay sending a signed copy to the seller, because under Texas law, the earnest contract cannot be enforced unless signed by both parties.
Not only does this delay a transaction, but if the earnest contract is not enforceable, it can lead to a host of other problems. A seller may be forced to refund the buyer’s deposit (a partial remedy for wrongful termination of the contract), or even worse, agree to a new purchase agreement (possibly at a higher value or new terms), saddling the seller with suffering a potential loss on the property they are selling.
Having the buyer sign the earnest contract as soon as possible, including obtaining the signature of the buyer’s spouse (where applicable) as well as the seller’s spouse (where applicable), will prevent these issues from unnecessarily complicating or ending an otherwise sound transaction.
Sample of an Earnest Money Contract
The earnest money contract is where the real estate sale transaction is initiated, and its uniformity helps keep the process moving along in an expedited fashion. A sample contract is shared below.
This form must be used when money is involved in the transaction. The property owner must fill out the residential real estate purchase agreement, and the buyer must complete the earnest money contract. This process involves the buyer having to post a certain amount of money as a "good faith deposit" to show that he or she is serious about the purchase. In short, for the contract to be legal and binding, it must be signed by the seller and buyer, and a broker and agent can not be the signatory.
The earnest money contract legally binds the seller and buyer into a purchase agreement. However, if the money was not given to the seller and the seller does not want to sell the property, then the seller can back out of the agreement. Even though earnest money contracts may use different wording, the main components of the contract are the same. An earnest money contract provides specific details about property being sold, including property to be sold, purchase price, and term of the payment plan.
For the buyer, the earnest money contract guarantees that the seller will not sell the home during the agreed-upon time, regardless of how much the buyer offered. It helps get the negotiations started between both parties. It includes a detailed description of the property, the tendency of the owner, any equipment or appliances included in the sale, and any defect in the property.
As a guide , the earnest money sample contract will follow:
- (1) Subject to the Seller meeting the Purchaser’s loan approval.
- (2) Credit application and purchase agreements are required to be signed by all parties to the sale. Payment shall be made to: The title company as escrow holder or agent.
- (3) The following conditions are incorporated herein: A survey and site plan shall be provided after funding.
- (4) The earnest money is paid to the agent: New York State Bank.
- (5) No interest shall accrue on the deposit.
- (6) All persons executing the contract shall be beneficiaries to the agreement, and the form shall be binding on the heirs, successors, and assigns forever.
- (7) Time is of the essence of this agreement.
- (8) Seller to pay interest to purchaser if the buyer has provided the funds for the purchase of the property.
- (9) This agreement may be canceled by either party within 90 days before the due date mentioned herein.
- (10) If the proceeds from the sale have not been received by the closing date or within the following 30 days thereafter, due to no fault of the purchaser, the purchaser shall be entitled to a return of the deposit amount.
- (11) Seller shall agree to not negotiate the property with another party until the loan application has been approved.
- (12) Should the purchaser default under the terms of this agreement, the earnest money shall be forfeited and become the property of the seller.
- (13) Seller agrees to an amount equal to the earnest money as liquidated damages to the purchaser for failure to close at the time herein specified.
- (14) This contract contains the entire understanding of the parties and no promises or representations have been made except as set forth herein, and is subject to being recognized by the court, and enforced under the Execution Creditor Act, Texas Property Code.
Legal Considerations (and Why You Should Use "As-Is" Clauses)
When it comes to earnest money contracts, legal considerations and recommendations are paramount. These contracts are enforceable legal documents, and as such, require a certain level of compliance with both statutory regulations and best practices. Here, we will discuss some of the legal requirements for earnest money contracts and some best practices that can help protect the interests of both the buyer and seller.
Legal Requirements
Investors and sellers must ensure that their earnest money contracts comply with state laws and real estate industry standards. While the exact rules may differ by jurisdiction, some common requirements for earnest money contracts include the following:
The inclusion of a written date for the offer, as well as a signed date for the acceptance of the offer, will help prevent any disputes over when the contract was entered into.
It’s important to note that real estate agents or brokers may also be subject to certain licensing and transactional restrictions in your jurisdiction. While agents and brokers typically have errors and omissions insurance to cover their obligations and potential liabilities related to earnest money contracts, property owners should consult with an attorney before proceeding with a transaction that uses earnest money contracts.
Consulting with an Attorney
When considering an earnest money contract, or any contract for that matter, your best option is to consult with an attorney. A lawyer can verify that the contract complies with state laws, that the buyer and seller are protected, and that the terms are reasonable. Importantly, they can also provide guidance to the property owner on what happens to the earnest money should the buyer back out of the transaction after the inspection period without good reason. An attorney can also advise how best to handle the earnest money should the buyer terminate the contract within the inspection period upon discovery of a defect in the home, whether it’s a major defect or a minor cosmetic issue that the buyer decides they don’t want to fix.
Best Practices
There are several best practices that are recommended for managing earnest money contracts and the earnest money deposit itself. First and foremost, it’s best to keep the earnest money separate from the real estate broker or agent. Keeping the earnest money in an interest-bearing account that only the buyer, seller and real estate agent have access to is the best option. If there are any disputes, the funds should be held in an escrow account until the issue is resolved.
Second, it’s best practice to have both the buyer and seller complete their own inspections and have the results of those inspections added to the earnest money contract. However, even if the property owner is not intending to list their property, the recommendation is to have an inspection performed to identify any potential issues up front. This will help prevent disputes later on.
Finally, consider retaining legal counsel to help with earnest money contract disputes, should any arise. Legal counsel can review the dispute to determine whether it is in your best interest to settle or take the matter to court.
Earnest Money Contract FAQs
When a buyer places an earnest money deposit with an offer to purchase, that document is usually titled "earnest money contract". These contracts are used in residential as well as commercial real estate transactions, although the terminology may be different for commercial contracts. This section provides answers to frequently asked questions regarding an earnest money contract, including binding contracts, deposit amounts, and whether to escrow the earnest money deposit or not.
What is an earnest money contract?
An earnest money contract is an agreement between the buyer and seller of real property for the sale and such other contingencies set forth in the contract. An earnest money contract is part of the purchase and sale agreement that the buyer and seller agree to after the buyer makes the earnest money deposit to buy the real property.
Is an earnest money contract a legally binding contract?
An earnest money contract, such as in the form of a RESIDENTIAL PURCHASE AND SALE AGREEMENT, or RP&SA, becomes a legally binding contract unless one or more of the following occur: What amount should I deposit? The amount deposited as earnest money will vary based on many circumstances. The size and scope of the deal will greatly influence how large of a deposit to make. Lenders often require an earnest money contract before they will issue a loan. A business vendor will not always require an earnest money contract. Unless the seller has more than one offer , an earnest money contract may be fairly inexpensive (often less than 2% of the contract price). If there are multiple offers on the same piece of real property, the Buyer should prepare to make a larger deposit to sway the property owner in their favor.
What if the transaction falls through?
Once an earnest money contract is created, the buyer submits the deposit. It is then up to the buyer and seller to ensure the requirements of the agreement are met. If the buyer does not perform according to the terms set out in the earnest money contract, they can lose their earnest money deposit. As long as the seller is performing their duties under the contract they are entitled to keep the deposit because it holds the buyer to the sales contract. Sometimes an earnest money contract is not enough to fully close the deal. The buyer and seller may decide to use an escrow account to finalise the transaction. This means that the seller or the buyer chooses a third-party company (such as a bank or real estate agency) to hold the deposit. The third party administers the funds and only releases them when both the buyer and seller agree to it or a court orders the funds to be released to the correct party. The use of an escrow agent is often a good idea when the buyer and seller live in different jurisdictions. It takes the pressure off of both parties to agree. The duty of distributing the money or property then falls to an impartial third party.