Legal Definitions - earnest money

Earnest money is a deposit made by a potential buyer to a seller, typically held by a neutral third party (such as an escrow agent), to demonstrate a serious and good-faith intention to complete a purchase. This sum acts as a sign of commitment to the transaction, most commonly in real estate deals.

If the sale proceeds as planned, the earnest money is usually applied towards the buyer's down payment or closing costs. However, if the buyer decides to withdraw from the agreement without a valid reason specified in the contract (meaning they default on the agreement), they typically forfeit this deposit to the seller. This forfeiture compensates the seller for the time the property was off the market and for other potential losses.

Here are some examples illustrating earnest money:

• Residential Home Purchase: A young couple, Emily and Ben, find a house they love and decide to make an offer. To show the seller they are serious and committed buyers, they include a check for $10,000 as earnest money with their purchase agreement. This deposit is held in an escrow account. If Emily and Ben later decide to back out of the deal simply because they changed their minds, without any contractual reason, they would likely lose that $10,000 to the seller. However, if their offer included a financing contingency and they were unable to secure a loan, they would typically get their earnest money back.

  This illustrates how earnest money demonstrates a buyer's commitment and provides the seller with a form of security against a buyer's unexcused withdrawal.

• Commercial Property Acquisition: A small business owner, Mr. Chen, wants to purchase a vacant commercial building to expand his operations. He submits an offer along with a $25,000 earnest money deposit. This significant deposit signals to the seller that Mr. Chen is a serious contender and that the seller can confidently stop marketing the property to other potential buyers while the due diligence and financing processes unfold.

  This illustrates that earnest money is not just a token sum, especially in real estate, and its size can reflect the scale of the transaction and the buyer's commitment.

• Land Development Deal: A real estate developer, Sarah, is negotiating to buy a large parcel of undeveloped land for a new housing project. Her offer includes a substantial earnest money deposit, contingent on her ability to obtain the necessary zoning approvals within 90 days. If the city council denies the zoning change, Sarah can legally withdraw from the purchase agreement and retrieve her earnest money, as she is not defaulting but exercising a contractual right. If, however, she simply decides the project is too much work after 30 days and pulls out without a valid contingency, she would forfeit the deposit.

  This illustrates that while earnest money shows commitment, its forfeiture is typically tied to a buyer's default, meaning backing out without a reason permitted by the terms of the contract.