Swoosh! Your contract to buy a new home may go up in metaphorical flames and cause financial loss if you don’t pay attention to the many kinds of buyer errors that can burn up earnest money.
Have legal questions about earnest money? Always consult with an attorney about your specific circumstances.
What is Earnest Money
Earnest money is a portion of the sales price offered upfront by a buyer to seller to initiate a contract. Generally speaking, it shows that the buyer is serious about the home purchase. Usually, the amount is at least 1 percent of the sales price, but varies depending on many factors, including local market customs and market conditions.
If a buyer backs out of or otherwise loses the opportunity to purchase a home, it may allow the seller to retain part or all of the earnest money. For example, a buyer may miss a contract deadline by not being able to get a loan on time. Other causes may range from buying a car during the loan application process, to losing important documents -- either of which can cause financing to fall apart due to the buyer's actions.
One major risk that causes buyers to wave goodbye to earnest money in tight real estate markets is an action called “waiving contingencies.”
If housing supply is limited and prices are high, the real estate market can become frighteningly competitive. Buyers may feel like they need to up the ante on their efforts in producing a competitive offer.
In a seller’s market, buyers often push their house hunting efforts and financial limits to the max. They find ways to track properties the minute homes come on the market. Sometimes they make offers that exceed a home’s asking price. Others may tempt buyers by showing they can make large down payments that will guarantee rapid loan approval.
"Knowledge is power! Ask your agent how your earnest money is protected in case the contract is terminated."
Buyers who aren’t in a position to exceed the sales price or bring loads of money to closing may think their only edge is to forgo contractual rights protecting them against financial loss.
Realtor.com notes that buyers are increasingly waiving contract contingencies that protect them when financing evaporates or home inspections discover problems requiring expensive repairs. For example, a loan may be denied if the property appraisal shows the home to be overpriced. This forces buyers to make a larger down payment and they may not have the cash available.
If an inspection contingency is in place, buyers can negotiate with the seller for the cost of repairs or a lower selling price -- or buyers can walk away from the deal and recoup their earnest money. In extremely competitive markets however, waiving inspection contingencies is increasingly common, and unfortunately puts the buyers at tremendous risk in the future.
Here are additional common reasons why buyers may lose earnest money.
Appearing Risky to Lenders
Lenders may deny loans if buyers seem risky to them for a variety of reasons. Here are two obstacles that buyers may not be aware of.
- Job changes: Taking a new job or becoming self-employed before being approved for a home loan is a bad idea. It makes you look financially unstable to lenders.
- Late Payments and Overdrafts: Pay your bills on time and monitor bank balances. Lenders see late payments and overdrafts as red flags of possible problems to come.
Harming Debt-to-Income Ratio
"Increased debt to income ratios are among the top reasons loans are denied at the last minute. Hold off on all major purchases during the loan process."
If you enter the financing process with sufficient income for home payments and little debt, you have a good debt-to-income ratio. But here are ways you can harm that balance and be denied a loan. Remember, if you don't get a loan on time, you likely will lose earnest money.
- New Wheels: Unless you want to end up living in your automobile, it’s bad timing to make such a big purchase while seeking a home loan.
- Debt Accrual: As much as possible, use cash for purchases instead of credit cards while awaiting your loan. Be sure to communicate the importance of careful spending to anyone for whom you have co-signed on a credit card or loan. Don't forget, you're equally responsible for their debt.
- Large Cash Deposits: Big bank deposits look sketchy when you apply for a loan. Lenders may suspect you've received an unreported loan.
- Income Changes: A job loss or demotion may kill your home loan application and cause you to lose your earnest money.
Failing to Meet Deadlines
Acting timely is crucial in all legal transactions, including home sales. If a buyer misses a deadline, the buyer may be in default, subjecting their earnest money to loss. Delaying a sale and thereby losing opportunities for bids from other potential buyers can cause financial losses for the seller, who may then be able to retain the earnest money.
Here are two examples of buyer deadlines.
- Loan Application: A home sale contract will specify the date by which a buyer must apply for a loan. It's best to set up the financing process before making a purchase offer.
- Inspection Objection: Remember the contingencies mentioned at the beginning of this article? If you retain your inspection contingency, you really don’t want to miss the deadline for approaching the seller with objections about property defects.
Not Providing Documentation
The process of buying a home may make you lose sleep and feel like you’re losing sanity. Here's one last thought to fuel your nightmares about tossing greenbacks into a bonfire: be meticulous about record keeping.
Save all financial correspondence, documents and receipts related to your income & any large expenses and/or purchases. Why? Because your lender will request copies of documents, particularly as it may relate to large deposits or transfers of funds. Don't take this personally, as it's usually the case that the lender and/or underwriter is simply complying with strict documentation standards. #hw