Earnest money is not legally required to form a valid contract, but it is customary in most real estate transactions. The deposit is typically held in an escrow or trust account by the broker, title company, or attorney. If the transaction closes, the earnest money is applied toward the buyer's down payment or closing costs. If the buyer defaults without a valid contingency, the seller may be entitled to keep the earnest money as liquidated damages, depending on the contract terms. The amount varies by market but is often 1-3% of the purchase price.
A buyer offers $500,000 for a home and includes a $10,000 earnest money deposit. The deposit is held in the listing broker's escrow account. At closing, the $10,000 is credited toward the buyer's purchase price. If the buyer backs out without cause, the seller may retain the deposit.
Remember that earnest money is NOT required for a valid contract — this is a common exam trick. The consideration in a purchase agreement is the mutual promises, not the earnest money. Also know that brokers must deposit earnest money into an escrow account promptly and cannot commingle it with personal or business funds.
Related Terms
Related Concepts
A purchase agreement is a legally binding contract between a buyer and seller that outlines the terms and conditions for the sale of real property. It is also commonly called a sales contract, purchase and sale agreement, or earnest money agreement.
Offer and acceptance is the process by which one party proposes specific terms for a contract and the other party agrees to those exact terms, creating mutual assent. This mutual agreement, also called a meeting of the minds, is an essential element of every valid contract.
A counteroffer is a response to an original offer that changes one or more terms of the offer, effectively rejecting the original offer and creating a new offer. The party who makes the counteroffer becomes the new offeror.
Consideration is something of value exchanged between parties to a contract, making the agreement legally binding. It can be money, a promise to act, a promise to refrain from acting, or anything else of value.
Contingencies are conditions written into a real estate contract that must be met before the transaction can close. If a contingency is not satisfied, the buyer can typically cancel the contract without penalty.
Frequently Asked Questions
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