Earnest money is a good-faith deposit made by the buyer to demonstrate serious intent to proceed with the purchase. Unlike the option fee (paid directly to the seller), earnest money is held in a neutral escrow account — typically at the title company, or sometimes at the broker's trust account. The contract specifies the amount, the holder, and the delivery deadline (typically within three business days of the effective date).
Failure to deliver on time: If the buyer fails to deliver earnest money by the contract deadline, this is a default by the buyer. The seller may terminate the contract and pursue remedies.
If the buyer defaults (refuses to close without a valid contractual basis):
If the seller defaults (refuses to close or misrepresents the property):
This is a critically tested area: a broker holding earnest money in a trust account cannot release it unilaterally when the parties dispute who should receive the funds. Release requires one of three things: 1. A written agreement signed by both parties (mutual release) 2. A court order directing disbursement 3. The specific conditions in the contract being met (e.g., proper termination during the option period)
TREC has no jurisdiction over earnest money disputes. If the parties cannot agree on disbursement, they must resolve the dispute through civil litigation or arbitration. An agent who files a TREC complaint expecting TREC to order disbursement of earnest money is mistaken about TREC's authority.
| Situation | Who Gets Earnest Money | |-----------|------------------------| | Buyer terminates during option period | Buyer | | Buyer terminates under Third Party Financing Addendum (financing unavailable, good faith effort made) | Buyer | | Buyer defaults after option period without valid basis | Seller (as liquidated damages) | | Seller refuses to close (seller default) | Buyer (plus potential damages) | | Mutual agreement to cancel | Whoever the parties agree in writing |
Real-world example: A buyer tries to terminate after the option period expires, citing "cold feet" rather than any specific contractual basis. The seller refuses to release the earnest money. The buyer demands a refund. The broker holding the funds cannot pick a side — even if the broker believes the buyer's termination was improper, the broker cannot unilaterally give the money to the seller. Both parties must either sign a mutual release or litigate the dispute.
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Quiz Questions:
Q1. A seller claims the buyer defaulted and demands the broker release the earnest money. The buyer claims the contract was properly terminated under the Third Party Financing Addendum. Neither party will sign a mutual release. What should the broker do?
A) Release the funds to the seller because the seller made the first written demand B) Release the funds to the buyer because the financing addendum is a valid basis for termination C) File a TREC complaint and wait for TREC to adjudicate the dispute D) Hold the funds and advise both parties to resolve the dispute through litigation or a mutual written agreement
Answer: D — The broker cannot unilaterally resolve a disputed earnest money situation by picking a winner. TREC cannot adjudicate earnest money disputes (C is wrong). The broker must hold the funds and advise the parties to seek legal resolution.
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Q2. A buyer defaults after the option period expires by simply refusing to proceed with the purchase without any contractual basis. What remedy does the seller have?
A) The seller must return the earnest money because the buyer has the right to change their mind B) The seller may retain the earnest money as liquidated damages for the buyer's breach C) The seller must sue for specific performance and cannot keep the earnest money D) The seller must first attempt mediation before being entitled to any remedy
Answer: B — When a buyer defaults without a valid contractual basis after the option period, the seller may retain the earnest money as the liquidated damages agreed upon in the contract. The seller can also pursue specific performance instead (but not both simultaneously). Keeping the earnest money is the more common and practical remedy.
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Q3. A buyer includes the Third Party Financing Addendum in the contract, specifying a 30-year conventional loan at a maximum rate of 7.25%. Three days before closing, the buyer is denied because interest rates rose to 7.5%. The buyer notifies the seller and demands return of the earnest money. Which statement is correct?
A) The buyer cannot use the financing contingency because interest rates are an external market force, not the buyer's failure B) The buyer is entitled to a return of earnest money because the available loan rate exceeds the maximum specified in the addendum, and the buyer made a good-faith effort C) The seller is entitled to keep the earnest money because the buyer should have locked in a rate earlier D) The broker must determine who is at fault and disburse accordingly
Answer: B — The Third Party Financing Addendum protects the buyer when financing meeting the specified parameters cannot be obtained despite a good-faith effort. The rate rise above the specified maximum is a qualifying basis for termination. The buyer acted promptly and is entitled to the earnest money refund.
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Q4. Earnest money is typically held by which party in a Texas residential transaction?
A) The buyer's broker, in the broker's personal bank account B) The seller, as additional security for performance C) A neutral escrow agent, typically the title company, in a trust account D) TREC, in the Real Estate Recovery Trust Account
Answer: C — Earnest money is held by a neutral escrow agent — almost always the title company in Texas. If held by a broker's firm, it must be in a separate trust account. It is never held in the buyer's agent's personal account or by TREC.
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Q5. The contract specifies that earnest money must be delivered within 3 business days of the effective date. The effective date is Monday, April 7. The buyer delivers the earnest money check on Thursday, April 10. Has the buyer delivered on time?
A) No — the deadline was Wednesday, April 9 (3 business days = Tuesday, Wednesday, Thursday) B) Yes — three business days from Monday includes Tuesday (Day 1), Wednesday (Day 2), and Thursday (Day 3) C) No — the deadline was Tuesday, April 8 (one business day after the effective date) D) Yes — the deadline is always the same week as the effective date
Answer: B — Three business days from the effective date of Monday: Day 1 = Tuesday, Day 2 = Wednesday, Day 3 = Thursday. Delivery on Thursday, April 10 is the last permitted day — timely, but barely.