Earnest Money Best Practices – How Much “Trust” is Needed in a Real Estate Transaction?

How do you know if you can trust someone? Earnest Money in Real Estate is, in theory, a financial good faith offering showing that you intend to purchase a property and perform tasks to close per contract guidelines and stipulations. But does Earnest money mean you can really trust someone to perform? It’s currently very common in Middle Tennessee to make an offer on a property with some “trust” money on the line to show a Seller that you have some skin in the game. If you mess up, you could risk losing out big time. Below are some of the most common Earnest Money best practices and stories according to Owner and Managing Broker, Liz Gatlin.

Earnest Money can be a game changer when comparing offers and terms of a Real Estate contract. Do you want to work with someone who has more or less money on the line to fulfill their obligations? Can you trust the other party in a transaction? Earnest Money does not mean you have to Buy a property, it just means that you intend to.

Small Town Vs. Big City Real Estate Dealings

As Nashville has grown, long over are the days when you could count on a handshake Real Estate deal. Back when Nashville still had that sought after “small town” feel, people would trust one another because word carries fast in small communities. People relied on each other’s word in business and deals because they knew each other, or knew someone who knew them.
A person’s reputation was the social currency exchanged in “Earnest” on many Real Estate deals. If you screwed someone over, you wouldn’t be able to do business with anyone else in the community who had received wind of your misdealing. Word would travel fast.
Now, with our global economy and growing urban city, Buyers and Sellers are moving here from all over the country and world. The most common way today to ensure someone’s viability and trustworthiness in Real Estate is hard cash money on the line.
In Nashville, Earnest Money has replaced reputation in a transaction. It isn’t necessarily the best way to vet a potential Buyer, but it is the industry standard in our market today. (Something that many local Brokers are considering doing away with… More on this later.) Ultimately though, Earnest Money shouldn’t be a deal breaker. You can never really “prove” that a Buyer is trustworthy and can close. You just have to trust in the process.

How Much Earnest Money Should You Expect to Put Down or Receive?

A good rule of thumb for calculating Earnest Money expectations is 1% of the total purchase price of a property. This will go up or down based on the stakes at hand, but for a median priced residential transaction, most Buyers should be comfortable putting between 1-3% in Earnest money.
This number can usually lower if supplemented with a Pre-Qualification Lender Letter, or financial commitment that shows funds are available to the Buyer. In Memphis, it is common to see $0 in Earnest Money if the offer is submitted with a letter from a lender showing that the Buyer has been pre-approved for a loan in the amount of the Purchase price.
Our office uses the $500,000 threshold as a benchmark for valuation if Earnest Money is going to be required. If a contract is for less than that purchase price there is not usually significant need for Earnest money as it becomes instantly diminished after legal fees. Ie. Fighting over who gets $1 or $2,500 on a sale nets all parties $0 after attorney fees. Why not use that energy to move on quickly in the hunt to find another able and willing Buyer?
This threshold of course is used lightly! There are many properties that would benefit from Earnest money being included in an offer under the $500,000 threshold. For instance, if you are a Buyer in a HOT market like ours, are going against cash buyers, or competition on a property is high, then you should by all means consider leveraging Earnest Money with your offer.

For transactions of existing residential homes, in moderate markets, and / or where the other agent is known, or due diligence timelines are shorter, Earnest Money often isn’t that critical to make a deal work.

Talk with your Southern Athena Agent for insights on how much Earnest Money is appropriate for your specific situation. For Sellers, Earnest money contract stipulations should definitely be considered when comparing offer strengths and weaknesses, but should not necessarily make or break a deal.

Who Should Hold Your Earnest Money?

Did you know that, Earnest Money disputes are the #1 complaint to the TREC – Tennessee Real Estate Commission? Issues with Earnest Money in a transaction can carry serious consequences for Buyers, Sellers, and Realtors alike. Who gets the money if a deal goes South?  How do you prove rightful ownership if a contract falls through? Who is responsible for holding funds and disbursing those according to legal contract language?
As a Broker, not handling other’s Earnest Money properly can result in steep license fines and even license suspension or revocation. Often if there is a problem with a contract the Earnest money becomes collateral along with the complicated legal dealings required to sort everything out. Co-mingling, or not depositing funds into the correct accounts within 24 hours after receipt is considered an issue and is against Commission rules and regulations for licensees. Properly handling client’s money is a duty owed by all Real Estate professionals.
Can you imagine if you wrote a check and found out 30 days later it was never deposited, or had been used to float an unauthorized expense by the holder? What if your money was no longer available at closing? You can see why TREC might think it best to strictly regulate handling of Earnest Money and Escrow accounts.
Before Southern Athena, I was previously affiliated with a national Real Estate company that LOST my Earnest Money check! Come to find out the check had been left on the receptionist’s desk for a month under a pile of papers. Talk about liability issues! Someone’s could have stolen my money, account information or identity before closing. Thank goodness it didn’t happen, but where your money is held should not be taken lightly.

We suggest Earnest Money always be held with YOUR closing attorney.

Before opening Southern Athena, I had many advisors suggest Earnest Money always be held by the transaction’s Closing Attorney or Title Attorney. For that reason, I elected to waive our Southern Athena Earnest Money Escrow Holding Account with the Tennessee Real Estate Commission for liability reasons. (Imagine getting sued because you interpreted a contract one way and an attorney says it should be another way…)

Though we still have an Escrow account for when we grow into other Real Estate related endeavors that require holding money on behalf of clients, it currently cannot be used without 1st giving notice to TREC. Therefore Southern Athena does NOT accept Earnest Money at this time.

What to Do if A Real Estate Contract Falls Through and Who Receives the Earnest Money

As Realtors, we are not allowed to provide legal advice or legal interpretation of contract language, and cannot technically advise a client on their legal rights to funds or disbursement of funds.  We use Association of Realtor Forms for all Residential transactions, prepared and updated yearly by the Tennessee Association of Realtors legal team, and have a couple of common scenarios that relate to a contract. If an Contract falls through, Earnest Money is usually disbursed in one of the following ways:

  1. Forfeited by Buyer and Paid to Seller per the Purchase and Sale Agreement
  2. Returned to Buyer for the following Reasons:
    1. Financing Contingency – ie. Buyer could not obtain financing or Appraisal did not meet or exceed lender requirements.
    2. Inspection Contingency – ie. Buyer found deal breakers in the inspection, or Buyer and Seller could not come to a formal resolution on matters involving the condition of the property and acceptable terms relating to repairs or price.
    3. Seller is unable to provide free and clear Title
    4. Other contingencies were not met. – Ie. Sale of another property for a 1091 Exchange
  3. Split Between the Buyer and Seller – See below scenarios
  4. Other…

Above is a snapshot of TAR’s Earnest Money / Trust Money Disbursement and Mutual Release of Purchase and Sale Agreement form used when a Residential deal falls through.

We know 1st hand, that though these seem like simple scenarios, there can be a lot gray area in a contract and what is right vs what the contract states. For instance, should a Buyer receive Earnest money back if he/she went and purchased a car before closing and now cannot get financing? Seems like a stupid mistake that should result in Buyer’s loss of Earnest Money, but this isn’t always the case. Now, what if the Buyer lost their job right before closing and cannot get financing? Should the Earnest money still be due to the Seller when the Buyer is hard on their luck?

Sometimes a contract falls through for reasons out of a party’s control. What if a Seller has recently passed and the kids are fighting over rights to the property, or creditors have liens on the property? Should the Buyer be entitled to damages for wasting time on a contract that does not have a free and clear title? Working through disbursement of funds can get pretty complicated.

We have even experienced where a Buyer’s title attorney was holding the funds and would not disburse them to the Seller without their client’s signature. Even though the Buyer was in default on the contract AND it clearly stated Earnest Money was non-refundable after a specific date, he still refused to let the Earnest Money go, and would not sign any paperwork to release the money. Legal discussions and heated conversations en-sued <—literally!

The best thing you can do when a Real Estate contract falls through is to stay calm and work amicably towards a resolution.

Talk with your Realtor and your attorney about your rights. We take extra care to keep detailed paperwork and all written correspondence on our transactions. We are able to quickly provide these to our client’s legal team to help expedite and resolve Real Estate contract issues. This documentation will be invaluable in helping your attorney best advise you of your rights per your contract and get you moving onto greener pastures with success.

Our Agents Are Trained in Earnest Money Do’s and Don’ts

Because of the above scenarios our Southern Athena agents are trained extensively in contract Do’s and Don’ts that could open you up to risk involving a Purchase and Sale Agreement and Earnest Money. Our experiences in Commercial Real Estate (Welcome to the Wild Wild West in ethics!) have shown us the many loopholes and ways sophisticated entities can sneak around a contract. Our agents are always working on your behalf and will be actively taking measures to protect your funds and mitigate your risk.  Holding to contract deadlines, educating you on common pitfalls, faux pas or worst case scenarios are all ways they will provide expert guidance and advice to service your Real Estate needs.

Our Southern Athena Policy Handbook includes some of the following Agent Guidelines for Earnest Money Best Practices:

If you are working with a Residential Buyer:
  • If the transaction is less than $500,000 suggest Lender Letter in leu of Earnest Money. If Earnest money is required by other agent, or there is high competition for the property, use Earnest Money for leveraging your offer strategically. Ie. Higher with higher competition, appease listing agent, a-typical situations like early occupancy, etc.
  • Buyer’s closing attorney should be with one of our Preferred Vendors
  • If Title is being paid by Seller, and Buyer is closing with Seller’s Title Attorney (To save everyone money) then Earnest Money should be held by that attorney.
  • Have client send a copy of check to you prior to sending, and follow up that it is deposited appropriately by contract deadlines. Send a copy of Earnest money receipt to all parties.
If you are working with a Residential Seller:
  • Seller’s closing attorney should be one of our Preferred Vendors or previous attorney used to close the Seller’s Purchase of the property (as applicable). Providing existing title from purchase can save up to 30% off of closing title expenses.
  • If Seller is paying for Title, Buyer should be closing with Seller’s Title company to receive cost of title discounts.
  • Buyer’s Earnest money should be deposited with Seller’s Title company.
  • Consider % of Earnest money as it relates to Financial contingencies. Higher % amounts should be considered for tighter lender restrictions, or lack of proof of financial performance such as a lender letter or bank statement showing cash funds.
  • Contract timing should state a reasonable time to for funds to be deposited: 3-5 Business days max after binding agreement date, or prior to inspection due diligence deadline.
  • Confirm and provide receipt of Earnest Money to all parties once received. If it is not received by contract deadlines, provide notice with TAR Notice Form.
Commercial / Land / Other Transactions:
  • Earnest Money should be held with YOUR client’s closing attorney or CRE attorney. Non-negotiable.
  • Consider staggered deadlines where Earnest Money will become non-refundable. Due diligence deadlines, damages to Seller, etc.
  • Earnest Money should be larger % of transaction if Buyer does not submit lender contact and letter.
  • Use good judgement on the word “Earnest”. If the Buyer seems sketchy, consider increasing the required amount. If the Seller has a lot of complicated legal language included in the contract, consider decreasing your Buyer’s liability.
  • Call me and let’s discuss appropriate amounts, timelines, and dealings with ALL Commercial / Land / or Other Sales on contracts involving deposits!
Note for Transactions: All Earnest Money must be deposited within 24 hours of receipt. Please coordinate confirmation and proof of receipt to align with your transaction deadlines and include a digital copy in your Southern Athena Transaction file folder.
If you or someone you know is considering Buying, Selling, or Developing Real Estate then please contact us today! We want you to know the implications of common real estate transaction components, like Earnest Money, so you can be better prepared for Real Estate success. Our experts strive to educate you to best protect your interests in every transaction. Not only do we have the best agents in Nashville, we have the experience to boot. Learn from our experience by speaking to one of our agents today!
Or call us to chat about your experience with the common signs of trustworthy and untrustworthy people. We love that too. There are many tells of dishonesty and deceit. Real Estate contract or not, it matters to us as we build positive influence and relationships in Nashville. We have our own small town southern “do not call list” of people who are unscrupulous. We would be happy to share those names if you are shopping around for vendors and want to know if someone is above board.
Also, a thank you to the photographers that provided some of our images: Allen TaylorNeONBRANDRuth Caron, Rawpixel, and Unsplash