NEWS


Sorry we are experiencing system issues. Please try again.
earnest-money-in-albuquerque

What Is Earnest Money?

What is Earnest Money?
Where Does An Earnest Deposit Go?
What Happens to the deposit at Closing?
What if You don't Close?
Can Earnest Money be Lost by a Buyer?
When can a Seller Keep the Earnest Money?
What if There's a Disagreement?
How do I avoid Earnest Money Problems?

What is Earnest Money?

Earnest Money is sometimes confused with a loan down payment.  When taking a mortgage to buy a home, buyers often pay “down” a percentage of the sale price in order to get a good interest rate or avoid mortgage insurance. The down payment can range anywhere from 3% to 20% of the purchase price, or more.

Ernest money is not a down payment. Earnest money is typically cash passed from the buyer to an escrow agent to be held in trust as a performance guarantee in a real estate deal. It has nothing to do with the loan process, although usually lenders will if and how the earnest money was paid as part of evaluating the borrower’s debt and income.

I’ll often refer to it as a “deposit” from here on. For this article earnest money and deposit are interchangeable.

In many markets across the United States, earnest money is a percentage of the selling price ranging from 1% to 10%.  In our Albuquerque real estate market it’s usually less than 1% of the negotiated home price. Here it’s often a default amount – say $500 or $1,000 – regardless of the purchase price.

As with all aspects of a real estate transaction, earnest money is negotiable. When I represent a buyer I work to keep the amount low, since that’s money put at risk. When I’m representing a seller I work to get a higher amount, since it’s money guaranteeing buyer performance.

The purpose of the deposit is to show that the buyer is serious, or “earnest”, about purchasing the property.  It shows commitment to the sale and is a way for the buyer to show they’ll act in good faith during the escrow period. It’s something the buyer is offering to pay the seller if the buyer doesn’t hold up their end if the deal. It’s money the seller may keep if things don’

Earnest money does not need to be cash. It can be a promissory note. A buyer may sign a document that promises to pay a certain amount if the deal does not close. The obvious issue with a note is collection and so this is fairly rare.  It can also be a car, a cow or a piano. Basically it’s anything the buyer and seller agree has value and will guarantee fair performance on the buyer’s part.

As part of the negotiated purchase agreement, the deposit is defined in amount, type of payment (cash, check, wire, etc) and payment date. If the deposit is not made correctly, the buyer has defaulted and the contract can be terminated. In fact, if the deposit is made incorrectly but still made, the default might be considered grounds for both terminating the agreement and the seller retaining the deposit.

Where Does an Earnest Money Deposit Go in Albuquerque?

All things real estate are negotiable, right? So where the money goes is decided by the buyer and the seller. That said, local convention often dictates handling and buyers and sellers often do whatever their brokers suggest.

Earnest money is typically due and payable upon the final execution of the contract – when all the parties have reached an agreement and signed it.  In most cases a buyer will hand a check to their broker. A broker can park the money in their own brokerage trust account, a specified escrow company’s account, or with the title company handling the transaction.

In Albuquerque real estate deals, almost all earnest funds are handed to a title company, most of whom act as escrow companies. One way or another, unless otherwise agreed to by both parties, the money needs to be placed in an institutional escrow account as defined by New Mexico law. Whether you are a buyer or seller, it’s critical you know before agreeing to a deal where the deposit will be going.

What Happens to the Deposit at Closing?

Earnest money is usually applied to the sale at closing. It becomes part of the down payment or purchase price. Section 4 of our New Mexico Purchase Agreement (NMPA) says specifically “Earnest Money shall be applied to Purchase Price, down payment, and/or closing costs.”

There are exceptions to this, cases where the earnest money is returned to the buyer at closing. Typically this happens when the buyer is taking a zero down loan and having their closing costs paid by the seller or the lender, as is typical in a VA loan or New Mexico MFA loan. In such cases, the deposit is held to guarantee performance, but when the deal closes, it’s returned to the buyer.

What if You Don’t Close?

So what happens if the sale falls through?  Who keeps the earnest money?  That depends upon the circumstances.  A carefully written purchase agreement will say clearly what should happen to the earnest money if a deal tanks. Much will depend on whether the buyer and the seller acted in “good faith,” i.e. acted honestly and sincerely and did what they were supposed to do when they were supposed to do it.

During the due diligence period of a typical purchase agreement, the buyer reviews physical and legal aspects of the property.  The closing of the purchase is “contingent” on the buyer’s satisfaction with what they find during inspections, surveys, title searches, review of homeowner association (HOA) and other documents.

Each contingency has specifics that need to be met to confirm agreed upon conditions and a deadline for how and when those specifics, that contingency, are satisfied. If issues pop up, when and how those are addressed should be spelled out clearly. As these contingencies are met and cleared, the deal is considered to be moving forward. If one of the contingencies does not clear, say, an inspection reveals a rotten roof and the buyer and seller can’t agree how to deal with it, the purchase agreement usually allows for the deal to be terminated.

If a buyer terminates a contract based on an agreed to contingency like that roof inspection, as long as it’s been done within the time frame and by the terms established contractually, the earnest money should be promptly refunded to the buyer.

Can earnest money can be lost by the buyer?

Absolutely. If the buyer does not work through their diligence in a timely manner, as agreed, and terminates the agreement, the earnest money can be retained by the seller. Say they found that rotten roof, but they didn’t inspect by the date agreed to. They would lose their right to terminate the deal based on that roof. If they walk away anyway, they can lose their deposit.

Earnest money also guarantees the buyer will perform and honor any financial commitments they make beyond the agreed purchase price.

I represented a seller on a deal in the Colorado Mountains a few years ago. A buyer made an offer based on the usual inspections and reviews. They wisely had a full survey performed. The seller declined to pay for the survey so the buyer agreed to be responsible for it. While all of the structural inspections were fine, the survey showed the cabin was within a few feet of the rear property line – too close for the buyer’s comfort.

The buyer had the survey done on time and according to the agreement. They terminated because of what they found, well within the terms of the agreement. They lost their deposit anyway. Why? They refused to pay for the survey as agreed. Since the surveyor may have liened the property rather than chase the buyer for payment, the seller insisted the survey be paid out of the earnest deposit.

Buyer and seller scuffled for a week or two, but the buyer finally relented and abandoned their deposit, which was then used in full to pay the survey. In this case, even though the buyer acted in a timely manner, they were still bound by agreement to pay for what they ordered and so lost the deposit. I’ll note here that as the seller’s representative, I backed the seller fully. In fact, it was my responsibility to fight for the retention of the deposit, which I did.

Why would the seller keep the earnest money if the sale falls through?

Because it’s provided for in the contract. In the above survey example, the seller didn’t actually keep the deposit, it was used to pay a bill. But there are certainly reasons the seller may be entitled to the deposit.

When a buyer and seller agree on a contract and the deal goes into escrow and its status in the Multiple Listing Service is changed from “Active” for sale to “Pending” close. The escrow period now for most deals in Albuquerque, particularly ones involving a mortgage loan, are often 30 days or more. During that time, the property effectively comes off the market. Once listed as Pending, brokers often won’t show it and potential buyers won’t see it on critical sites like Zillow or Realtor.com. Valuable market time will be lost during the escrow period. If the deal does not close, potential buyers may have moved on to purchase other properties.

Further, the seller may have spent money that hinged on terms of the contract, like paying for an appraisal or a survey.  The seller may have paid for certain repairs or upgrades that had been negotiated as part of the deal.

Sellers often are buying or renting another property, which deal is keyed on their own sale. They may be spending money as buyers on inspections, appraisals, etc. They may make deposits on a moving van or pay to put items in storage. A seller may sign a lease and pay a security deposit for a rental. If their own sale fails, money spent on their prospective deal may be lost.

Of course, all real estate deals have some risk of not closing. Contracts, diligence periods and deposits are all designed, if engineered well, to mitigate that risk as well as possible for both parties. But they won’t eliminate that risk fully. If a buyer walks away from a deal without just cause, a seller is entitled to compensation for lost marketing time or other costs.

Sellers should also know that their brokers may be entitled to part of that earnest money. Though no longer typical in New Mexico listing agreements, the seller and their broker may agree that the broker will receive part of the deposit if a deal falls through and the buyer forfeits the deposit. This to compensate the broker for their own time and expenses during the escrow period.

What Happens if the Buyer and Seller Disagree on Who Gets the EM?

As with everything in a real estate transaction, this should be spelled out in the purchase agreement or related documents. If the standard NMPA is used, it will stipulate who holds the money and what happens to it in the event of a failed deal. In various sections of the NMPA, what happens to the earnest deposit in certain circumstances is spelled out.

For example, NMPA section 6, A., says that the buyer must show evidence to the seller they have the cash or ability to get a loan to make the purchase and must prove so in writing by a certain date. If they fail to do so or the seller doesn’t like the proof, the seller has the right to terminate the deal and, in this case,must give the deposit back to the buyer.

Regardless of what the purchase agreement says, if the contract terminates and the buyer and seller can’t agree on who gets it, the holder of the deposit will most likely refuse to release the money until an agreement is signed by both parties.

Per sections 30 & 31 of NMPA, buyer and seller agreed to first try mediation, where a neutral party tries to work out an agreement. If that doesn’t work or they can’t agree on a mediator, the next step is likely civil court. At that point, the deposit holder may continue to hold the funds until the court hands down instructions. The deposit holder may also step out of the situation by “interpleading” the earnest money – hand it to the court while the matter is settled.

In a dispute, the skill and knowledge of the brokers or agents representing the buyer and seller will be key to a quick resolution. Whether you are buying or selling a property, it is important you discuss earnest deposits with the person who will represent you.

Be leery if your broker or agent simply hands you a form called the Earnest Money Information Sheet (NMPA Form 2310). It’s a useful document, but you want to know in detail how they will help you handle various situations. You also should ask about their experience in prior disputes. Think twice about hiring someone who is vague or has no experience in deposit disputes.

If you are a seller, it may be best to walk away from someone who believes earnest money should be minimal or not collected at all. In my prior brokerage, R1 New Mexico, we regularly discussed this at managing broker meetings. Many of my fellow managing brokers believed earnest deposits should not be collected. They even discouraged the Realtors under them from collecting it. This was not to protect sellers; it was so those brokers could avoid any involvement in disputes. This was something I disagreed with strongly.

How Do I Avoid Earnest Money Problems?

Obviously, if a deposit becomes an issue, it may be a long time before the issue is resolved. With attorney fees and court costs it may be an expensive process. It can leave hundreds or thousands of dollars tied up for months or possibly years. When you enter into a real estate purchase agreement, read everything you sign carefully and make sure you understand everyone’s’ duties and responsibilities.

Yep, like many states in the good old USA, New Mexico has created long, complicated real estate forms that can be mind-numbing for the uninitiated. Regardless, it’s up to you to read every word and understand your obligations and rights.

If they are experienced and good at what they do, your broker or agent should be able to help you understand the main issues in involved in the various forms. But if you have questions they can’t answer or are unsure of, you need to ask an attorney. In fact, it’s perfectly acceptable for your broker to suggest you bring an attorney in. By law, as brokers and agents, we are limited in what we can do to interpret purchase agreements for our clients. If there’s an unclear issue, we are duty bound to refer you to an attorney.

But again, make sure your broker or agent is experienced in earnest money issues, has a clear understanding of them and can clearly communicate that understanding to you. Hey, if they can’t clearly outline things to you, how will they be able to help you if a deal goes south?

If you take the time to go over the agreement carefully with your Realtor, it should be pretty clear what you need to do to preserve your rights to that earnest money on either side of the deal. If you are a buyer, you need to perform your evaluations on time and as agreed and work closely with your lender to expedite the loan process. If you find an issue that needs to be resolved before you are comfortable closing the transaction, you need to deal with that issue in a timely fashion as agreed to in the agreement.

If you are a seller, the same thing stands. You need to make sure you provide access and documents as agreed to. If you agreed to have a survey done, for example, it needs to be delivered when and as agreed. If inspections are to be done, you need to make sure fair and reasonable access to the property is given in the time frames stipulated. Documents, like title and HOA, must be delivered on time.

In real estate deals, communication is key. Your broker or agent’s job is to make sure that happens. You need to keep an eye on the calendar and the clock and your broker should be advising you on that frequently and accurately. When an issue comes up, it needs to be dealt with clearly, honestly and swiftly. Modifications to the agreement, if needed, must be made in timely fashion, in writing.

If everyone understands the agreement made, does their part to honor it and acts reasonably and in good faith, earnest money issues and disputes should be rare or minor.

I’m happy to go over the purchase agreement and how it addresses earnest money with you in detail. Just drop me a line.

– Joe LaMastra, RealABQ Real Estate Services, September 13, 2019

  • Joe LaMastra

    Joe LaMastra
    (505) 506-6866
    200 Broadway Blvd NE
    Albuquerque NM 87102

    Contact
  • News Archives