- Real Estate
- 7 mins
When purchasing a home, putting down an earnest money deposit is one of the first steps in showing the seller that you're serious about your offer. Typically ranging between 1% and 3% of the purchase price, this deposit can amount to thousands of dollars. While the earnest money deposit demonstrates good faith, it also raises the question: what happens if the deal falls through, and how can you protect your deposit?
Understanding the potential risks and legal protections around your earnest money is crucial to avoid costly mistakes. Let’s explore some key strategies to safeguard your deposit and ensure that you are protected throughout the homebuying process.
What is Earnest Money and When is it Due?
Earnest money, often referred to as a "good faith" deposit, is typically submitted once your offer to purchase a home is accepted. It’s a way of demonstrating your commitment to completing the transaction. If the deal moves forward, the earnest money is applied toward the down payment or closing costs. However, if the deal falls through, your deposit can be at risk depending on who is in breach of the agreement. Recovering your earnest money will depend on the circumstances and more importantly, the terms outlined in your purchase and sale agreement.
Contingencies: Your First Line of Defense
One of the best ways to protect your earnest money is by including contingencies in your purchase offer. Common contingencies include:
Financing Contingency:
If you are unable to secure a mortgage, this contingency can allow you to back out of the deal and receive your deposit back. All mortgage contingencies outline a specific date that the buyer has to obtain financing. If they cannot obtain the necessary loan amount before that date, then there is the potential that the buyer can walk away from the deal. If both parties still wish to move forward however, there is always the possibility for both sides to renegotiate the terms of the agreement.
Inspection Contingency:
If the home inspection reveals significant problems, this contingency allows you to withdraw your offer and reclaim your deposit. Most inspection contingencies specify a certain dollar amount that the buyer is willing to accept to repair or fix any significant items that the inspection uncovers. For example, a competitive offer may specify that the buyer can only back-out of the deal if the inspection reveals over $5,000 or $10,000 worth of repairs that need to be done. This protects both the buyer and seller, as the buyer is willing to take on minor repairs that the seller doesn’t want to deal with.
The buyer is further protected if the inspection reveals a significant problem that requires immediate attention and any unexpected expenses (water damage, asbestos, foundation issues, etc.). This is the primary protection that an inspection contingency provides, as no homeowner wants to purchase a property only to come across a substantial issue or expense after the closing has already occurred. This is especially important in a state like Massachusetts that operates under the notion of “Buyer Beware.” For a full breakdown of Massachusetts law when it comes to buyer disclosure, please read our legal blog post here.
Appraisal Contingency:
If the home appraisal comes in lower than the agreed-upon sale price, this contingency gives you the option to renegotiate or exit the contract without losing your deposit. Typically, when the appraisal value falls short of the actual offer price, the lender will not provide a mortgage in any amount exceeding the appraised value of the home. Thus, appraisal and financing contingencies often go hand-in-hand.
But in competitive markets such as Massachusetts, some buyers will include an appraisal guarantee clause (sometimes referred to as an appraisal gap clause). This clause states that if the value of the appraisal comes in below the offer price, the buyer will be responsible for covering the difference. For example, you offer to buy a home for $500,000, but it is only appraised for $490,000. If you included an appraisal gap clause in your offer, this means that you would be willing to come up with the additional $10,000 to make up for the “gap” between the appraisal price and the purchase price. These types of clauses were used frequently during the Pandemic when it was not uncommon for buyers to make offers that were well above a given asking price.
This contingency gives the seller added reassurance that regardless of the appraisal value, the buyer will make up the difference between the appraisal price and the offer price, ensuring that the deal doesn’t fall through as a result of a low appraisal coming back.
By including these contingencies, you can safeguard your deposit against unforeseen issues that may arise during the home buying process. Once your offer to purchase a home has been accepted by the seller, there are very few avenues that allow you to back out from the deal. The aforementioned contingencies are some of the smartest ways to build in protections that grant you more flexibility when purchasing.
Be Aware of the Timeline and Deadlines
Real estate transactions operate on tight deadlines, and missing one can result in the forfeiture of your earnest money. For example, if your financing falls through after the financing contingency deadline, you could lose your deposit. Or perhaps your inspection contingency specifies that the inspection must occur within 7 days, and you miss this window, you will be in violation of the agreement and could lose your initial deposit. Having an attorney involved ensures that all deadlines are met and that you have a clear understanding of the implications if they are not.
Negotiate the Terms of Your Earnest Money Deposit
It's essential to negotiate clear terms for the release and refund of your earnest money in your purchase and sale agreement. For instance, you may want to negotiate terms specifying how disputes over the deposit will be resolved. Often, the escrow agent holding the deposit may require written consent from both buyer and seller before releasing the funds, which could complicate things if there's a disagreement.
An attorney can help you negotiate favorable terms and ensure that your deposit is protected from unfair forfeiture.
Avoid Common Pitfalls
Some common situations where buyers lose their earnest money include:
- Waiving Contingencies: While waiving contingencies might make your offer more attractive to a seller, it can put your earnest money at risk if things go wrong. If you waive all contingencies, you are essentially locking yourself into this transaction as there will be no means to back away from the deal. Think carefully before waiving any protections.
- Backing Out for Non-Contingency Reasons: If you simply change your mind about the home or decide not to move forward without a valid reason tied to a contingency, the seller is likely entitled to keep your deposit.
- Failing to Meet Deadlines: As mentioned earlier, missing key deadlines in the contract, such as the financing or inspection periods, can put your deposit at risk. Ensure all deadlines are carefully tracked and met. Almost all offers to purchase and purchase and sale agreements in Massachusetts include the phrase “time is of the essence.” This emphasizes that time is a material term to the contract. Thus, if a deadline is missed, the party that committed the violation has breached the contract.
Why You Need a Real Estate Attorney
In Massachusetts, real estate transactions are complex and often involve significant amounts of money. Hiring a real estate attorney that you trust can provide peace of mind and protect your earnest money deposit. Since Massachusetts requires a closing Attorney to be present and substantially involved in a real estate transaction by law, it is imperative to select a real estate closing attorney that has your best interests in mind. A closing attorney can help you:
- Review the Purchase Agreement: Ensure all terms, contingencies, and deadlines are clearly outlined and protect your interests. For our full overview of the purchase and sales agreement and how our attorneys can help you navigate it, please read our legal blog here.
- Track Critical Deadlines: Help you meet all deadlines in the agreement, reducing the risk of forfeiting your deposit. Time is of the essence when it comes to real estate transactions, in both a literal and a legal sense. With critical deadlines being a part of every legally-binding real estate transaction, it is crucial to have a trusted closing attorney that will keep you well informed throughout the entire sales process.
- Negotiate Disputes: If the deal falls through and the seller tries to keep your earnest money unfairly, an attorney can help negotiate the return of your deposit and even take legal action if necessary.
In short, having an attorney review your purchase and sale agreement and assist throughout the process is one of the best ways to ensure your deposit is protected.
Protect Yourself
Buying a home is an exciting but complex process, and protecting your earnest money deposit should be a priority. By including contingencies, being aware of deadlines, negotiating favorable terms, and seeking legal advice, you can safeguard your deposit and avoid unnecessary financial losses.
Working with an experienced real estate attorney, such as those at Lane, Lane & Kelly, LLP, is essential in Massachusetts, as they can guide you through the process and help ensure that your transaction proceeds smoothly. At every stage, from making or reviewing the offer to closing the deal, your attorney will help protect your rights and your investment.
Protect your deposit and make your home buying experience as stress-free as possible by contacting the real estate attorneys at Lane, Lane & Kelly. We understand the intricacies of Massachusetts real estate law and have proudly been helping our clients with all real estate matters and conveyances since 1938. Click the link below to contact us today to get started!
This blog is made available for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. By reading this blog you understand that there is no attorney client relationship between you and Lane, Lane & Kelly, LLP.
