Releasing Earnest Money to the Seller. You did what now???

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If you’re like me, there are more than a few things going on in our world today that make you throw your hands in the air and go “WHAAAAT? (optional string of expletives here).” And, if you’ve been trying to buy a home in Seattle any time over the last, oh, 3-5 years or so, you also know it’s often a blood bath out there. Demand is far out-stripping supply, and this year Seattle earned the dubious honor of being the fastest growing city in the U.S., according to this Seattle Times article published last May.

This often means several buyers have to compete with one another over homes for sale, and we have seen some instances of homes receiving upwards of thirty offers, and selling 150K (or more) above the asking price. One well-publicized instance of this was this 1,100 square foot home in Ballard that sold for 717K (and that wasn’t even the highest offer)!

But this is increasingly causing sheer recklessness on the part of buyers, and some of their agents, too. My least favorite example is a fairly recent development whereby buyers are releasing their earnest money to the seller upon mutual acceptance (or shortly thereafter), as a “non-refundable deposit.” I’m curious to know where and how this got started, because it’s unfair to buyers, and also seems to be riddled with potential legal issues.

$100 billsIf you’re new to the home buying process, here’s the deal: a purchase and sale agreement stipulates anamount of money a buyer will deposit with the escrow company (the neutral third party who handles the ins & outs of closing the sale) within two business days of mutual acceptance. The dictionary definition of earnest, is “showing depth and sincerity of feeling.” So, the buyer is putting up money prior to the closing of the sale to show the seller they intend to close- and that they aren’t just running all over town making offers on dozens of houses at a time, in the hope that something sticks. In our market, anywhere from two to five percent of the home’s list price is usually considered acceptable earnest money, and obviously if a buyer is putting up five percent or more, it tends to further entice the seller to accept their offer.

In a “normal” market, a buyer’s offer would contain contingencies, protecting their earnest money. Probably the three most common examples of contingencies are inspection, financing, and title (but there are others). If the buyer does an inspection and finds out the house is about to fall in to a sink hole, they can withdraw their offer, and the earnest money is returned to them. If the buyer is pre-approved, but then loses their job after mutual acceptance (and therefore the ability to qualify for financing), their financing contingency would likely keep their earnest money safe. And if something showed up on the home’s title that prevented the seller from being able to sell the house, a title contingency would make the earnest money refundable to the buyer.

In this “not normal” market, it has almost become, well. . . normal, for buyers to waive all of these contingencies, and literally GIVE their earnest money to the seller as non-refundable, even if the SELLER can’t close. “Well when wouldn’t a seller be able to close?” you ask? I’m sure the list could go on and on, but a few things that float to the top of my mind:

  • if the sellers were a married couple, and one of them filed for divorce while the house was in escrow
  • if the seller died after mutual acceptance
  • if the IRS filed a tax lien on the house after mutual acceptance
  • if a natural disaster caused catastrophic damage to the property (giant trees fall over on houses in Seattle. . . it happens)
  • if the house burned down while it was in escrow
  • if an unforeseen cloud showed up on title: I won’t go in to detail on this for the sake of brevity, but it’s happened to me once, and it can absolutely hold up a sale, or render a home un-sellable.

So, imagine this scenario: my 5% down, pre-approved buyers are looking at homes up to a 600K price point. This means they have managed to amass around 30K plus closing costs, let’s call if 40K. A nice home in a good location comes on the market for 550K, and it quickly becomes clear it will get several offers, and the price could easily escalate to 600K. My buyers will absolutely need to waive their inspection contingency, so they can either shell out $450 bucks or so for a pre-inspection on a home they have maybe a 1 in 7 chance of owning, or “take their chances” that there are no major issues. Increasingly, buyers are waiving their financing contingency even when they are financed. This also requires a leap of faith on the buyer’s part that there won’t be any hang-ups with getting their loan underwritten, that the appraisal will come in at value, and that they won’t have any significant changes in financial circumstance while the deal is in escrow. A title contingency is sometimes the buyer’s last line of defense- in a nutshell, it states that if an issue comes up on title after mutual acceptance, the seller has to get it cleared up, and if they can’t, the buyer is entitled to a refund of their earnest money. However, even putting this protection in for buyers is becoming increasingly pooh-poohed by sellers and listing agents. So back to my buyers. They really want this home, so, they waive all these contingencies, and elect to put up really strong earnest money of 35K. They release this earnest money to the seller ten days after mutual acceptance as a non-refundable deposit. A week before closing, the seller dies in a car accident intestate (not having made a will). That sale isn’t closing, and my buyers have now lost their down payment, and probably their life savings.

Washington state’s Law of Real Estate has two clauses that immediately come to mind, but I’m sure that’s just the tip of the iceberg: in its general duties of a broker section, the very top line (1a) is “to exercise reasonable skill and care.” And more to the point, it says when representing a buyer, again line 1a: “To be loyal to the buyer by taking no action that is adverse or detrimental to the buyer’s interest in a transaction.”

Hmm. . . I just helped my buyer lose thirty five thousand dollars, knowing it was possible. Did I just violate those two laws? I know what I would say if I were the judge.

So where and how did this start? I honestly don’t know, but it’s disturbing that it’s being peddled as “the new normal.” A recent article on the Redfin blog alludes to it as one of their “secrets” for winning a bidding war, while simultaneously distancing themselves from it by stating “we’ve seen buyers” [do it]. Windermere now has a brokerage-specific addendum (form WRE41) which allows a buyer to go down a checklist of all the things they are waiving in their offer. To their credit, under the release of earnest money it does stipulate that this does not apply in the event of seller default. But then. . . if the house burns down, did the seller default? Or did the house just burn down? I dunno.

Rather than trying to figure out “who started it?” I say we real estate professionals come together, agree it was a bad idea, and make the sensible and fair decision to put a stop to it. However, I’m pretty sure this won’t actually happen until some people get sued. . . and lose.

Roger Steiner
Roger Steiner
Since 2005, I have been helping home buyers and sellers in Seattle achieve their real estate dreams!

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