What Is Earnest Money and Why Does It Matter?
Earnest money is a deposit a buyer provides to a seller as a sign of good faith when entering into a purchase agreement. The amount is typically 1% to 3% of the purchase price, but it can vary by market and local custom. This deposit demonstrates the buyer’s commitment and provides the seller with some compensation if the buyer defaults.
Because earnest money can be a significant sum-often tens of thousands of dollars-both parties have a strong interest in ensuring it is handled fairly and securely. That is where a real estate attorney steps in.
The Attorney's Role in Escrow
A real estate attorney does not simply hold the money. Instead, they manage the escrow process, which is a neutral third-party arrangement. Here is how they typically handle it:
- Drafting the escrow clause: The attorney ensures the purchase agreement specifies who holds the funds (often the attorney’s trust account, a title company, or a licensed escrow agent), the amount, and the conditions for release.
- Holding funds in trust: If serving as the escrow agent, the attorney deposits the earnest money into a dedicated trust or escrow account, separate from their own funds. This is required by state bar ethics rules.
- Verifying compliance: The attorney checks that the deposit is delivered on time and in the correct form, such as a certified check or wire transfer.
- Coordinating release: The attorney follows the contract’s terms to determine when the funds should be released to the seller (upon closing) or returned to the buyer (if the deal falls through and contingencies are met).
Common Contingencies That Affect Earnest Money
The contract typically includes contingencies that allow the buyer to cancel and get the earnest money back. An attorney helps ensure these are clearly stated. Common examples include:
- Inspection contingency: The buyer can withdraw after a home inspection reveals defects.
- Financing contingency: The buyer can cancel if they cannot secure a mortgage or loan commitment.
- Appraisal contingency: The buyer can walk away if the property appraises for less than the purchase price.
- Title contingency: The buyer can back out if title issues are not resolved.
When a contingency is properly exercised, the attorney will direct the escrow agent to return the deposit. If a contingency is waived or not triggered, the funds typically move toward closing.
Disputes Over Earnest Money: What Happens?
Disagreements over earnest money are among the most common disputes in real estate transactions. For example, a buyer may cancel after an inspection, but the seller might argue the issue was already known or trivial. An attorney’s role here includes:
- Reviewing the contract terms to determine which party is entitled to the funds based on the facts.
- Mediating between the parties to reach a voluntary resolution.
- Issuing a written release if both parties agree on the outcome.
- Holding funds in trust until the dispute is resolved (often limited by strict deadlines, such as 30 days).
- Escalating to court action if no agreement is reached. In some states, an attorney may file a petition for interpleader, allowing the court to decide.
Attorneys cannot simply choose a side-they must act as impartial escrow agents unless hired by one party. Always consult your own attorney for your specific situation.
Best Practices for Buyers and Sellers
To avoid complications, keep these points in mind:
- Read the contract carefully: Know the exact deadlines and contingencies that affect your deposit.
- Keep records: Save all communications, inspection reports, and receipts related to the deposit.
- Use a neutral escrow service: An attorney’s trust account or a professional title company provides protection for both sides.
- Ask questions early: If you are uncertain about a clause, an attorney can explain it before you commit.
Final Takeaway
Real estate attorneys play a critical backstage role in managing earnest money deposits, ensuring funds are secure and released only according to the contract’s terms. When handled properly, escrow protects both buyers and sellers from financial loss. State and local laws vary significantly, so always verify rules with current law and consult a qualified attorney for your transaction.