The Cost of Changing Your Mind
What is Earnest Money?
Earnest money is the price you pay to take a property off the market. If you’re a renter, it’s customary to offer one month’s rent as earnest money. If you’re buying a home in Chicago, the amount varies, but can be as high as 10% of the purchase price for a new construction home.
In the event that the deal goes through, it is applied to your purchase price. For home buyers, this means that the earnest money may well be more than your down payment. You’ll get it back at closing.
If the deal falls through, you lose the earnest money. This means that you’d better be really sure that you want to commit to the place before you put that money down. (In fact, that’s why buyers customarily request a chance for an attorney to review their offer before they put down all of their earnest money.)
Basically, it’s a ransom that you pay while the seller or landlord holds hostage your ability to shop around for other properties. By taking a property off the market, they’re in turn forfeiting the right to potential better offers that might come along while they wait for your deal to close.
It’s a Payment, Not a Loan.
Once you put down your earnest money, you need to consider that money as spent. If you’re buying a home there are a few ways you can get the money back, but if not, you should not consider it a loss. You should consider it as the price you pay to the seller/landlord for their lost market time.
I get a lot of questions from renters who have committed to an apartment wondering how they can get their earnest money back. I work with plenty of buyers who view the idea of losing their earnest money as a terrible thing. These folks are looking at it from the wrong perspective. Earnest money is always a negotiable thing. When you set the amount you want to offer as earnest money, you need to consider what it is worth to know that at least one acceptable property in this fast-moving market is reserved for you.
Reasons Why You Might Get it Back
For renters, there’s only a handful of reasons why you might get your earnest money refunded.
- The apartment isn’t ready on your move in date.
- You don’t meet the landlord’s criteria to sign a lease.
- Something catastrophic happens to the building or apartment before you move.
- Basically, if it’s the landlord’s fault or choice that prevents you from moving in, you can get it back.
For buyers, refunded earnest money depends on the contingencies that you put into your offer. I’ve discussed contingencies before in passing, but here’s a quick summary of SOME potential “outs” that you could add into an offer. (Bear in mind that too many contingencies will kill an offer outright, so don’t go overboard.)
- Attorney deems the contract to be illegal.
- The seller does not have right to sell the property.
- Inspector finds major structural flaws, environmental hazards or code violations.
- The condo association is in severe disarray.
- You cannot sell your current home.
- The appraisal value of the property is much lower than your requested mortgage.
- The condo association doesn’t meet your lender’s standards.
- Destruction of the property before closing.
- You can’t get the mortgage approved in a timely manner.
- The rent roll reveals problems in an apartment building for sale.
- The seller’s lender won’t approve a short sale offer.
- One of the neighbors has a restraining order against you.
There are plenty more, but in all cases if you want to be able to get your earnest money back the contingency must be specified in the purchase contract.
These Reasons Probably Won’t Work.
I say “probably” because a clever attorney may be able to wriggle you out of a contract even if your real reasons are in the next list. In most cases, though, these reasons for walking away from a purchase contract mean that your earnest money will become payment for services rendered.
- You changed your mind.
- Your roommate changed their mind.
- You adopted a puppy and the building doesn’t allow pets.
- You die, but your spouse survives. (This could result in getting declined for the mortgage, but does not terminate a contract on its own.)
- You suddenly discover that you’re expecting another child and will need a bigger home.
- You have a horrible nightmare about the property that freaks you out to much to move there.
- Your employer is transferring you to another country. (Again, this may mess up your loan application but won’t kill the contract.)
- You discover that a sex offender lives next door.
- The neighborhood elects a new Representative/Senator/Alderman that you despise.
- Your dog doesn’t like the house.
- A family member dies and leaves you a much better house in their will.
Basically, if the reason that a deal doesn’t go through involves the seller, a third party or both sides, then there’s a good chance that you’ll be able to get your money back. If it’s entirely your side that’s causing the problem, then you will need to walk away from that money.
Friday we’ll be talking about mortgage insurance. See you then!