There are few things more complicated for buyers and sellers than a home sale failure. A failed home sale is emotionally and financially difficult for all the involved parties. Careful preparation and attention to deadlines can make or break outcomes. So how do things sometimes go so wrong?
Know How Earnest Money Works
A California home buyer should be prepared to offer an earnest money (“good faith”) payment to the seller when a Residential Purchase Agreement (RPA) is created. The amount is typically 1-3% of the total purchase price. Sometimes buyers will offer more in a highly competitive market.
The earnest money is held in trust by a neutral third party, usually the title company or escrow company involved in the transaction. It is due at the time of the offer, or within one-three days after the signing of the RPA.
After contingencies are removed (appraisals, inspections, financial or mortgage arrangements) the sale of the home is closed, and the earnest money is applied to closing costs.
What If the Buyer Wants to Back Out of The Sale?
It happens! Houses fail inspection, appraisals fall short, and buyers sometimes fail to qualify for the mortgage they need to close the sale. These are all legitimate reasons for buyers not to go through with the sale. As long as the buyer backs out in a timely manner (this is all in the sales agreement) the earnest money is returned to the buyer. Life goes on.
However, if the buyer backs out for other reasons, after the contingencies are removed, things get complicated. Buyers change their minds for all kinds of reasons, like a sudden medical event, finding another home they like better, or getting “cold feet.” This is called a breach by the buyer.
Meet the Liquidated Damages Clause
A buyer who backs out of a deal impacts a seller by wasting their time, temporarily making the property appear sold to better potential buyers, and causing unplanned holding costs and legal expenses.
The Liquidated Damages clause prevents the seller from escalating the actual damages of the seller, and caps the return of the buyer’s deposit (title or escrow payment) at 3% of the home’s purchase price.
How to Avoid Legal Issues with Earnest Money
The easiest plan is to know exactly what kind of home you want, do all the due diligence you can to limit surprises, enter negotiations confidently and in good faith, and provide a sensible amount of earnest money.
Savvy sellers should understand the liquidated damages clause has teeth; if a sale does not go through after all contingencies have been waived, the seller can keep the deposit. If a buyer refuses to sign and forfeit the deposit, the buyer is responsible for all damages that flow from the breach, such as the difference in the original sale price and what it eventually sold for, extra mortgage payments and taxes due to extended undesired ownership.
If you are involved in a failed home sale, contact an experienced real estate attorney as soon as possible.
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