What happens to earnest money if client decides not to buy the house?

Answer 1

You aren't holding the money from a 30 day option to purchase that wasn't exercised; you're holding a partial payment for an incomplete transaction. In theory you can assert a demand for specific performance (sale of the house at the agreed price) and hold on to their money temporarily while you perfect the contract by completing the transaction with another buyer. In practice you return the earnest money and move on. Here's why...

First you should be aware that holding that money will make you unpopular with your real estate agent and all the other real estate agents in your area. If you tie up that cash, then its not just your deal that doesn't go through, its whatever house the buyer would have bought instead and the sale of whatever house they're in, or the finder's fee for renting the unit they're renting now to someone else. (and so on for those people ad infinitum) You're blocking the whole chain of deals and commissions. If the real estate community begins to think of you as a "problem" they only show your place to a buyer if they've seen every other listing they have, including MLS. You might find that taking the typical 15-20% beating doing a "For Sale By Owner" and placing ads and charm school courses on how to show it yourself becomes an attractive alternative to never selling the place.

Second, when you hold the money and then sell the house on less advantageous terms you only have a claim against that earnest money for the difference, not the whole amount. In essence you hold the money while you complete the deal that wasn't finished and get the results you would have had from that deal. Unfortunately, in the interim you have to hold that money in trust in a segregated account because isn't even partly yours until the house is sold, you're just holding it in case you have a claim against it. You have to manage the money carefully to generate a decent income without risking any losses, make regular reports to the other party about how much money there is and where its held etc, and then promptly refund whatever is left. You also become responsible to the other party for the sale you make, condition of the house until then, a prompt sale, and so on. If you make any mis-steps you may have to absorb those losses instead of them. You can be held liable as a fiduciary and punitive damages in addition to actual damages could also apply. If you make a better deal, you have painted yourself into a corner by insisting on the deal you made with the first buyer and now have to pay both the extra profit and the earnest money to the people from the first deal whose money you have been holding.

Unless you haven't been paying attention, on balance keeping the money is not an attractive option. You annoy the people you're depending on to sell the place, you give up all rising market profits and assume a boat load of obligations that can wipe out whatever falling market insurance you get.

This is why you smile and say "I'm so sorry we couldn't do business today." and return their check.