Real Estate Attorney and Family Law Blog.(Vol I.11)
by Craig Franklin Chambers, Esq. The Littleton Lawyer.
In my practice as a real estate lawyer and divorce lawyer, in Littleton, South Jeffco, Denver, Highlands Ranch and Lone Tree, I often conduct reviews of residential real estate contracts. This is especially true since the market has recently improved. I am also an active licensed real estate broker for over thirty years.
The question arises with every contract: how much earnest money should I put down?
Earnest money is the money you put up-front for the transaction. If your purchase offer fails, the earnest money check is never cashed. If your offer is accepted, it shows your good faith intent to purchase the property. The title company or listing broker holds the earnest money in a trust account and credits it back to you at closing, reducing the down payment you need to bring to closing.
The purpose of the earnest money is to compensate the seller if the transaction fails. The seller may be damaged by inconvenience, additional mortgage payments, costs of moving, lost marketing time, etc. Because these types of damages are difficult to prove, the parties agree on a specific amount in the contract.
That amount is the amount of the earnest money. It is referred to as "liquidated damages" in the contract. In a liquidated damages contract, the earnest money is the only compensation for the loss of the transaction that the Seller receives. In a specific performance contract, which is rare, the seller is entitled to retain the earnest money and is also entitled to sue the buyer to proceed with the transaction.
The listing broker will usually state the amount of earnest money the seller is requesting in the advertisement for the listing. That amount is subject to the negotiations between the buyer and the seller, same as any other contract term.
If you are the Buyer of the property, the earnest money should be as little as possible. The general rule is under 10%, but my advice is more like 1-1.5% of the contract price. The higher the price of the property, the higher the earnest money. As a higher end buyer, you are expected to have more assets. A typical buyer is buying with limited down, usually 3% and the buyer also has to pay closing costs.
The Buyer's earnest money is at risk if the transaction fails, but only after all the contingencies have passed. There are numerous contingencies in the standard Colorado Real Estate Purchase contract, including contingencies for satisfactory title, inspection, appraisal, HOA covenants, insurance, survey, as well as the ability to secure satisfactory financing.
After the deadlines for these contingencies passes, or if the notice requirements attributed to each is not followed, the earnest money becomes non-refundable and is forfeited by the Buyer. If the transaction fails because of one of the contingencies, say, for example, the home fails inspection, or the appraisal comes in low, and the proper timely written notice is given to the Seller as per the contract, the earnest money is refunded to the Buyer.
Practically speaking, earnest money is rarely forfeited. The Buyer has so many outs, it is rare that the earnest money is actually ever at risk. Even if the transaction fails after all the contingencies are removed, the earnest money will not be released unless the Buyer and Seller agree and sign an earnest money release.
If the parties can't agree, the parties are required to attend mediation. If that fails, a lawsuit can be filed. In addition, if the transaction fails, under the standard Colorado Real Estate Commission listing agreement between the Seller and the listing broker, the earnest money is split between the listing broker and the Seller.
For these reasons, I also suggest a small but reasonable amount of earnest if you are the Seller, say between 1-1.5%. Some brokers recommend a higher amount, but it is better not to demand an amount that is worth fighting over. You do not want to scare away qualified buyers. If the buyers have the assets to satisfy the lender, that should be sufficient.
Although a disgruntled buyer cannot tie up the title of the property or prevent a subsequent sale over an earnest money dispute, given the number of outs the buyer has in the contract, and the inconvenience and expense of litigation, it is usually better to simply refund the buyers earnest money, find another buyer, and move on.