Understanding Earnest Money

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What is Earnest Money?

There is usually a significant amount of time between the acceptance of a real estate contract the home’s closing. At closing, the possession of the property is legally transferred from one owner to another. During this time between contract and closing, earnest money is held in an escrow account as a show of good faith between the two parties that they intend to honor the agreed upon contract.

When is Earnest Money Tendered?

In Illinois, earnest money is often tendered twice during a real estate transaction; first when a contract is initially agreed upon, and second once attorney review has been completed. The first, or initial earnest money is tendered when two parties initially agree to a real estate contract. It is a showing of good faith from the buyer to the seller, and makes the real estate contract valid.

Many times, after both the buyer’s and seller’s attorneys have come to terms regarding additional items not laid out in the initial real estate contract (thus concluding their attorney review period), the buyer will tender second earnest money. This shows the seller that the buyer intents to move forward with the deal in good faith and will do all in their power to close within the terms of the contract.

Where is Earnest Money Held?

By law, earnest money must be held in an escrow account dedicated to earnest money. Many times, the seller’s brokerage holds the money in their escrow account, however, it can also be held by either attorney, or by the title company that will facilitate the closing as long as it is held in an escrow account dedicated to such funds.

What Happens to Earnest Money?

Hopefully, the transaction process is smooth starting from the initial contract, during attorney review, and to the closing table. When your real estate transaction closes, all the earnest money that was tendered by the buyer gets applied to the purchase of the home.

Unfortunately, not all real estate transactions close.  When deals are canceled, both the buyer and the seller must agree upon how the escrowed earnest money is to be dispersed BEFORE the funds can be released to either party. If both parties cannot agree upon how funds are dispersed, then a legal judgement must be issued before funds are returned.

In most cases, if the deal ends during the attorney review period, the earnest money funds are returned to the buyer.  The seller only has legal rights to the earnest money in escrow if the property doesn’t close due to default by the buyer and that default is not listed as a contingency in the real estate contract. (See next month’s post about common real estate contract contingencies).