Episode 106: What is Escrow?

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Earnest money contracts to buy real estate are something every buyer and seller should be familiar with. Although most are familiar with a one to four-family residential contract, there are those that can also be put together for farms, ranches, commercial office buildings, commercial properties, and industrial properties. Regardless of the type of property, it can be advantageous to enlist the help of a reputable and knowledgeable real estate attorney to assist with the different components of earnest money contracts.

How Earnest Money Works

Earnest money is typically put down in the form of a check that is paid to the title company to hold on to until the transaction terminates or is fulfilled. However, it is worth noting that there are forfeiture provisions that can go into effect if certain things do not happen. If the property is not closed upon, the buyer is at risk of losing their earnest money. A real estate attorney may be helpful in dealing with a more complex escrow situation.

More recently, a termination option has become available in which a buyer will pay a fixed amount of money in markets that are considered a buyer’s market, in which there is a great deal of product available. These options are usually low numbers of approximately $100, $200, or $500 and allow the buyer the option to terminate if they see something they do not like or for no particular reason. In this case, the buyer forfeits their termination fee which the seller keeps, but the buyer typically wants the rest of their earnest money back.

However, at present, there is a much tighter market with not a lot of product, so some of these termination provisions are at a much higher number that buyers are putting up in order to more effectively attract a seller. It may even be possible for the buyer to waive their termination option entirely to make themselves more competitive in attracting a seller. A buyer’s higher termination option number or waiver may make them stand out from all the other bidders and make a seller more likely to accept their contract.

The Role the Title Company Plays in Earnest Money Contracts

Most of the time the title insurance company gets involved in the process. The purpose of a title insurance company is:

• To go through the process to make sure that the seller has a good title
• To ensure there are no liens
• To determine that the borders are properly defined
• To make certain there are no easements or judgments that affect the property

This process is in place so that a buyer knows that they actually are buying the property and there are not expected to be any legal problems that come up afterward. However, should there be legal problems that crop up afterward, there is an insurance policy that will help pay the cost of fixing that property or paying the damages caused by the title problem. The seller typically pays for the title policy, but it is an option for the buyer to pay for it.

The title company generally takes over the process of closing. They will get a title report out showing liens, easements, problems that exist, and whether or not they get eliminated or it is just something the buyer has to understand.

The title company will provide that report and work out whatever needs to be worked out regarding that and makes sure that any liens, taxes, or homeowners association dues that are outstanding are paid at closing.

Usually, the buyer’s money (or lender’s money) goes to the title company who will then pay the taxes and the former mortgage company and any other liens necessary to clean it up and then disperse the excess monies (if any) to the seller.

Surveys and Inspections as Related to Earnest Money Contracts

Typically, when buying a home, a survey is done. In cases where there are lots, blocks, and subdivisions, it is typically not that difficult to do. Farms, ranches, and places with larger acreages can be a different story.

There are also usually inspections where the buyer will send an inspector in to make sure of things such as whether the plumbing works and that the roof and foundation are good and that there are no mechanical or physical problems with the home.

There are survey reports and inspection reports. Generally speaking, the buyer has an opportunity to object to those things and either require an allowance to fix those things or require a seller to fix them before closing. Once those objections are resolved and the financing is set up, the title company can conduct a closing.

The Real Estate Closing Process

The buyer’s lender (usually a mortgage company, bank, or third-party lender) will want to have a valid first lien on the property. For this reason, the mortgage company will get involved and look at the survey and the title report to make sure they are getting a clean first lien on a property that is going to have value.

An appraisal is also typically done to make sure the property is worth enough to support the loan. Sometimes there can be problems with appraisals, although not as much recently because values have gone up. In tighter markets, you may have a contract for a $300,000 house that only appraises for $280,000, which means the borrower may not be able to close.

There are provisions and contracts that can give a buyer the option to get out of a contract if they do not meet the financial requirements. However, in the current market, some buyers are waiving that to be more attractive to sellers.

The closing date is a key provision in an earnest money contract.  It generally sets the date at which the buyer must either buy or be in default of the contract. Sometimes there may be extensions granted voluntarily if an inspection is taking too long or there is some other reason a closing is delayed, but everybody still wants to get the deal done. There are forms a realtor can distribute to the buyer and seller to extend that date.

Ultimately there is a date at which the transaction needs to take place or the buyer will be in default. Or, if the buyer shows up and the seller wants out, the seller could be in default. After the closing takes place, the seller will turn possession over to the buyer.  This basically means giving them the keys and having the seller move their stuff out if they have not already.

Are Earnest Money Contracts Enforceable?

When done properly, an earnest money contract is enforceable.

There can be lawsuits for defaults on earnest money contracts. However, be forewarned that it ties up the property and can be expensive. It is often difficult for a seller to enforce a contract against a buyer just because they can sue them for damages (generally what it costs the seller to find a new buyer, the difference in price, and the carrying cost of the property going forward).

Even if there ends up being a judgment against a potential buyer, that judgment may or may not be collectible. At times, these things can fall out because the buyer did not have enough money to do the deal, and maybe not enough money to pay the judgment of the lawsuit. There are situations where there may be a wealthy enough buyer willing to pay money to get out of the contract and would have some problems with having a lawsuit and getting a judgment against them that they would rather pay some sort of compensation to the seller for the seller’s loss in connection with a broken earnest money contract.

On the flip side, a buyer who wants to enforce a contract against a seller that wrongfully backs out of a contract may have a better choice of remedies. The seller has the property, a lawsuit can be filed, and a lis pendens can be filed in the real property record, which lets the world know that the title to that property is the subject matter of a lawsuit, and whoever buys the property from the seller is taking it subject to the rights of the lis pendens holder, or the potential buyer in this example.

One caveat to the notion that a buyer can sue the seller and recover something is that if the seller has a large mortgage on the property, then there may not be much the seller can do because the mortgage company would likely foreclose on the property, wiping out the interest the seller had, leaving little money for the buyer to collect from the seller. This type of situation is not good for the buyer.

By Harold "Hap" May, P.C. on May 20, 2022   /   Blog, The Legal Play Podcast   /   Leave a comment