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You’ve accepted an offer on your house from a buyer that included a sizable amount of earnest money, but now they’re backing out of the sale due to coronavirus uncertainty. Is that deposit yours to keep?
“Who is legally entitled to the earnest money depends on what causes the sale to be cancelled and when it is cancelled, explains Justin Meyer, a real estate attorney licensed in Florida, New York, and New Jersey. “However if the buyer loses their job after the mortgage approval contingency period, and the approval is revoked, they could be at risk of losing their escrow deposit.”
Even if you do get an offer while selling during the pandemic, the timeline could be loose, or the deal could fall apart. While some buyers are simply walking away from their earnest money, others are not.
This understandably puts you, the seller, in a tough spot, especially in light of new coronavirus amendments that give buyers extra leeway in the contract. Let’s take a look at how coronavirus has changed the stakes in terms of earnest money — and where you stand as the seller.
How earnest money works
Earnest money is a good faith deposit meant to commit your buyer to closing on the deal, but real estate contracts are rarely ironclad. Even prior to the pandemic, buyers had three main contingencies that allowed them to walk away from the deal while keeping their earnest money:
- Inspection Contingency: This contingency grants the buyer a set number of days to conduct a physical home inspection. If the inspection reveals serious, undisclosed issues, the buyer can back out of the purchase without losing their earnest money.
- Appraisal contingency: This contingency comes into play if the property does not appraise at the purchase price. If that happens, the buyer can back out of the sale, sometimes because the bank will not approve a loan for more than the appraised value.
- Financing Contingency: This contingency allows the buyer to back out if they are unable to ultimately get a mortgage to finance the purchase. This is the contingency most likely to come into play in this scenario, as many buyers find themselves unexpectedly furloughed or otherwise unemployed due to COVID-19.
A deal could fall apart for any of these reasons both pre- and post-pandemic — and in most cases the earnest money would leave right along with your buyer. Now, as for a home sale that falls apart specifically due to COVID-19? That adds another layer of complexity.
How COVID-19 complicates earnest money
“I have had buyers lose earnest money because of COVID-19. One buyer tested positive for COVID-19, so they signed a termination and walked away, leaving their deposit on the table. That was before the coronavirus addendum came into circulation,” recalls Hartford, Connecticut-based, Move Safe Certified agent Amy Rio.
If the buyer and seller cannot come to an agreement as to who gets to keep the earnest money in a sale derailed due to coronavirus, a court may have to decide.
Rio shares a case where the buyer was furloughed during the transaction. The earnest money is now in litigation.
“I’ve even seen loans fold the day before closing because the buyer’s funding no longer meets the new criteria for COVID-19 funding,” Rio says.
But the outcome could depend on where you live.
“In California, there is a bright line test that can help determine whether the seller has a right to retain the deposit, or whether the buyer has a right to a refund after a failed escrow. The test is whether the buyer has removed all of its contingencies,” says Valerie H. Li, a Los Angeles-based real estate attorney and a member of Schorr Law, APC.
“For buyers and sellers waking up in the COVID-19 era in the middle of a deal, the buyer can refuse to remove a contingency and cancel a sale without penalty. Where the disputes are now arising are where all contingencies have already been removed, but the buyer wants to cancel and retain the earnest money deposit due to COVID-19.”
6 ways to determine who keeps the earnest money
Every home sale is unique, and so are the reasons for canceling a sale. Figuring out who should rightfully keep the earnest money in your case comes down to the answers to these six questions.
1. Did the real estate contract have a coronavirus addendum?
The three contingencies above are standard in most home sale contracts, however they don’t specifically address the unusual issues arising in these unprecedented times. That’s why many contracts are now including a coronavirus addendum.
“The COVID-19 addendum states that an automatic extension is granted if needed during the pandemic, as long as the need for the extension is not the fault of either party,” explains Rio.
“If the extension is simply because the financing or processing is taking longer due to new rules that have come into play, then the buyer is granted the automatic extension rather than put into default.”
Since many businesses are experiencing shutdowns and delays, and even essential services like real estate companies are operating with a skeleton crew, it’s best for your own stress level to assume that it will take your home sale longer to close than normal:
“The partial or full closures, or reduction in staff seen in local agencies, lending institutions, title companies, escrow companies, and the courts have impacted the timing for transactions,” says Li.
“Parties can expect obstructions and delays somewhere along the process that can really derail a purchase.”
2. What were the terms of the addendum?
While there are no accepted national terms for a coronavirus addendum that applies across the nation, the terms set by Realtor associations in different states are quite similar. For example, Li explains the form currently in use in California:
“The California Association of Realtors Coronavirus Addendum (C.A.R. Form CVA, 3/20) was prepared specifically to address the parties’ rights and obligations –– including a buyer’s right to cancel with or without penalty. Terms may include those that postpone the sale by 30 days and allow the buyer to cancel at the end of the 30 days if escrow cannot be closed for any reason.”
In other words, the coronavirus addendum means it is never too late to renegotiate the purchase and sale agreement to allow for a fair outcome that takes into account a buyer’s changed circumstances due to COVID-19.
Florida Realtors have come up with a similar coronavirus addendum, however, as Meyer points out, the addendum is not automatically added to every COVID-19 era home sale contract. In addition, the addendum does not specifically mention what happens to the earnest money:
“The addendum is not required and it does not address earnest money at all,” says Meyer. “If a date is missed by the buyer, that is where the earnest money comes into play.
“However, the Florida Realtors coronavirus addendum allows for extensions of time for any aspect of the contract, such as a longer inspection period, or a longer mortgage contingency period, for either a set number of days or an open-ended time period — say, until the state of emergency declaration is terminated.”
3. Is the buyer protected by other (non-coronavirus-related) contingencies?
A coronavirus addendum is specifically designed to address those contract-breaking issues that may arise due to COVID-19. However, buyers’ rights to retain their earnest money are still protected by those standard contingencies. This is true even if the reason that the contingency comes into play is directly related to the pandemic.
The economic uncertainty wrought by COVID-19 is most likely to trigger the loan contingency.
“I recently had a sale where the financing contingency came into play on the buyer’s side because our buyer got laid off. Even though the job will be there when this is all over, the lender wouldn’t approve financing because nobody has any idea when this will truly be over,” recalls Spokane, Washington-based real estate agent Cambria Henry.
Job security isn’t the only coronavirus-related reason that a buyer may walk away via the financing contingency. Since COVID-19 hit, the requirements to get an FHA loan have become stricter, meaning that even some pre-approved buyers may no longer qualify:
“FHA loan criteria has changed tremendously during the pandemic. Previously, a credit score of only 620 was required, and reserves were not required,” explains agent Amy Rio.
“But now 80% of lenders are requiring a 680 credit score for an FHA loan, so a lot of buyers no longer qualify. I’d say a solid 10% of my buyers no longer qualify to purchase a home with an FHA loan since COVID-19 began.”
4. The buyer has no protection from an addendum or contingency. Is the seller entitled to the money?
If there are no contingencies to justify backing out of a contract, it may be difficult for a buyer to retrieve their earnest money deposit. However, there is another standard clause that may impact the rights to the earnest money should a dispute arise between the buyer and seller: the force majeure clause.
Put simply, the force majeure clause is standard contract language that removes liability should the contract be broken due to natural, unexpected, and unavoidable catastrophes — say, if the seller’s house is destroyed by a hurricane or tornado before the sale closes.
However, it’s still undecided whether the COVID-19 pandemic will be deemed as a natural disaster that legally triggers the force majeure clause.
It’ll take a court case to decide whether or not force majeure is applicable, but it’s not worth getting into a legal battle if legal fees will cost you more than the total amount of earnest money.
“The force majeure clause in Florida contracts does not specifically state whether a pandemic/epidemic is covered, so it is not clear if Covid-19-related cancellations are covered under the clause.
“For most people, a $1,000 or $2,000 escrow may not be worth the court costs. However, a larger escrow deposit will change that. Sellers will need to see how much money is at risk and how much they are willing to spend on an attorney.”
The uncertainty of how courts may rule also holds true in California, as Li explains:
“Although some contracts have the force majeure provision that a buyer may use to get out of a purchase, there is no certainty that California courts will interpret the COVID-19 crisis as an ‘act of God,’ or some unforeseen and unpreventable event, that allows parties to completely withdraw from a contract without any penalty.
“Equity or fairness suggests there may be some relief available but unfortunately, there is no bright line test. This is going to be decided on a case by case basis by judges and juries.”
5. Let’s say, legally, you’re entitled to the money. Should you take it? What’s the right thing to do?
Unfortunately, there has currently been no ruling that spells out exactly how real estate contract disputes over earnest money should be handled during the COVID-19 pandemic.
It could turn out that you (the seller) are legally entitled to the earnest money because the buyer no longer had any contingencies to turn to when COVID-19 negatively impacted their financial state. If that’s the case, keeping the money might be legal, but it may not be morally right.
“Let’s say someone is furloughed after a mortgage commitment was made, and there are no conditions left in the contract to give the buyer an out. In this situation, there’s harm done to both sides,” says Rio.
The seller is harmed because they’ve had their house off the market and they’ve still been carrying housing costs while in escrow. The buyer is harmed because they were furloughed or lost their job due to COVID-19 so they simply can no longer purchase the property.
At that point, it’s understandable for buyers to ask for their earnest money back, and it’s also understandable that the sellers also expect to keep the money.
It’s a sad situation for both parties who are both suffering a loss. When it’s not clear cut which party legally deserves to keep the earnest money, the right thing to do is to decide who gets the money based on which party is in more dire financial straits.
6. Is there anything a seller can do to protect themselves?
“It’s actually really difficult for a seller to keep earnest money,” explains Henry.
“For example, In Washington buyers don’t have to be approved for a loan before making an offer on a house, as long as they apply for a loan within five days of the offer being accepted.
“If their financing falls through, they get their earnest money back — unless the seller has used their right to terminate the financing contingency, which they can do after 30 days.”
In general, standard real estate contracts are written to protect the interests of both the buyer and the seller. Coronavirus addenda, on the other hand, tend to favor the buyer, because it extends those tight contingency timelines — often automatically — to grant the buyer more time to get an inspection, appraisal, and loan approval done.
That addendum is sensible for both parties, because social distancing and stay-at-home orders have caused delays that make meeting those deadlines near impossible.
However, it has also caused escrow periods to drag on longer than planned, which some sellers may not be able to afford. For example, maybe you are currently carrying two mortgages because you’ve already purchased your new home.
For sellers who are at all worried that they may not be able to keep up with expenses if the sale drags on for weeks longer than expected, your best option may be to ask your agent if skipping the coronavirus addendum will keep the escrow timeline on track.
However, that may not be necessary. Many buyers who are walking away from a home sale due to coronavirus concerns, aren’t even asking for the earnest money back:
“As of now, most buyers are simply walking away from their deposit if they’ve been furloughed or lost their jobs. Or they’re asking for extensions to push the closing out for eight weeks, hoping they get rehired after the furlough,” says agent Amy Rio.
Keeping your sale on track
Many families are facing economic hardship right now, so it’s only natural to wonder what will happen to the sizable earnest money deposit if your home sale falls through due to COVID-19.
While it might seem smart to cut your losses and take that earnest money if you can get it, it’s wiser in the long run to work out a way to keep your home sale on track.
You never know what will happen to home prices in the future. If the economy doesn’t recover swiftly after the COVID-19 pandemic passes, then home prices may suffer.
If your buyer is open to staying in escrow for an extended amount of time in the hopes they’ll re-qualify for a mortgage after the stay-at-home orders are lifted — and you can both afford to do so — then go for it.
It’s better to keep a serious buyer committed to purchasing your home than hope you’ll get another offer down the road for the same amount once COVID-19 has subsided.
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