When your financing evaporates, do you lose your earnest money?

This is not legal advice. For legal advice, consult an attorney, not a blog.

In this challenging market, many buyers are discovering that their loan program is no longer available. This is a particular problem with new construction, whether condo or house. The buyer signed a purchase and sale agreement (PSA) several months or even years ago. Back then, in the “good ol’ days,” lenders offered a variety of financing options. Some buyers relied on some of the more “aggressive” options (e.g., an option ARM) in order to qualify for the new home. Today, that financing option is gone, gone, gone, and the buyer can no longer afford to buy the property. What happens then?

Well, the short answer is that the buyer loses the money. In almost every new construction contract, the builder’s addendum will note that the financing contingency, if any, is waived within several weeks of signing the PSA (and months or years before closing). Once the financing contingency is waived, then the risk of a failure of financing rests squarely on the buyer. At that point, if financing fails, it is the buyer’s problem, not the seller’s. Accordingly, if the buyer cannot close as a result, then the buyer will lose the earnest money as the buyer is in default of the PSA.

However, there may be more to the contract than what is seen by the untrained eye. There are a variety of state and even federal laws that apply to the sale of property, and in particular new construction. In many instances, these laws create “loopholes” in the contract that allow the buyer to at least arguably rescind the contract. Thus, depending on the terms of the PSA at issue, these laws can be used to exert negotiating pressure on the seller to at least return some of the earnest money.

Certainly, a buyer should not rely on these laws when signing the PSA originally. Every buyer should be aware of the risks and obligations created by a contract. But sometimes, the buyer’s situation changes (to put “America’s Money Crisis” mildly) and the buyer can no longer perform. Heck, sometimes the buyer may just decide that the purchase is actually a bad idea and not want to complete it. Under those circumstances, the buyer should consult an attorney to determine if there is a mechanism by which the buyer can get some or all of the earnest money back.

22 thoughts on “When your financing evaporates, do you lose your earnest money?

  1. This is actually one of the reasons why it may be best for a buyer to use the builder’s lender instead of an independent lender for new construction. The contracts in our area (Santa Clarita, CA) generally state that the buyer must be able to obtain a loan, although possibly not the loan that the buyer was originally quoted. If the buyer cannot obtain a loan from the builder’s lender, quite often the deposit is returned.

    Not so on California resales… once contingencies are removed about 17 days into the contract period, the deposit is at risk if the loan cannot fund. Some sellers will refund the deposit if they have another buyer in hand, but many will not.

  2. A couple weeks ago I ran across a builder addendum regarding financing. It was an eye-opener for me. It mentioned that the borrower had to get prequalified BY the builders “preferred” lender. Period. And, that if the buyer did not obtain financing from the builders preferred lender that the borrower would forfeit any premium upgrades (lot location, physical upgrades to the home etc). Further, if financing was obtained outside of the builders preferred lender, the buyer, as a condition of their offer being accepted, must provide the builders preferred lender with the Good Faith Estimate provided by the buyers loan officer. (presumably to have the preferred lender LO try to match it. I’d love to dissect the final HUD’s on those transactions.)

    To me, at first blush, two things come to mind. The builders lending partner is giving kickbacks to the builder in one form or another and the disincentive for the buyer to obtain financing elsewhere is off the chart. Smacks of RESPA/HUD violations, but perhaps I’m mistaken.

  3. Just how common is it these days for buyers to lose their funding? Is it more than 10% of deals? Has this started happening more frequently in September than in August?

  4. Actually, it would also be interesting to hear how common it is for buyers to lose funding on existing home purchases (i.e. non construction)? Have the number of cases where someone who’s offer was accepted on an existing home finds they can get financing increased in September from August?

  5. Sniglet, it’s very uncommon for buyers to lose funding – – – – (wait for it) – – – because buyers are very uncommon! 😉

    The NWMLS addendum is a bit more buyer friendly, but there is a new clause with recent amendments requiring seller approval to change lenders. Buyers need to consider that.

  6. Using the builder’s lender is a terrible idea IMO. The LO will do anything to get that loan approved without considering the borrower’s best interest.

    I recently had a conversation with someone who is locked into a new construction purchase (I am not her lender). They’ve been in contract for months and this person has realized they have a stated income loan and now want out.

    I asked her what her thoughts were when she saw the loan ap with the OVERstated income and she said she just wanted the house.

    I think it’s in a buyers best interest to work with individuals who are not connected so that they are all (hopefully) serving the buyer instead of working together to serve themselves.

    That LO know’s he’s fed by the builder…he’s not going to tell the builder that the buyer is not qualified if he can find someway to shoe-horn him/her in.

  7. Rhonda, have you seen many loans go poof?

    I’ve been hearing from more and more people on the street that they think financing is gone, but I’ve yet to hear a mortgage professional mention anything.

  8. We’ve had a few transactions (purchase) go by-by. And, we have a boat load, at ton, of idle files (mostly refi’s) waiting to either proceed to close or get canceled. Some have been sitting idle for weeks.

    We did get a couple FSBO’s in this week, which was interesting.

  9. I’ve been on both sides of this as a builder myself and as a listing agent for a builder. Having a preferred lender for new construction is super common, and I don’t think the intentions are usually sinister. (though I’m sure there are unscrupulous examples out there) First, it helps to market the property if you have some “financing options” already worked out. Second, when builders require a buyer to qualify through the preferred lender, it serves as a sort of check and balance that the person is indeed qualified, since normally you are relying on a pre-qual letter from an unknown lender. As a builder, I trust the lenders I work with and when they say they can get a loan done, I believe them. The same cannot be said for some other lenders in the market.

    Ultimately, though, builders motivations are not kickbacks from lenders. They need to get their inventory sold, and it doesn’t matter who the lender is. Do your own diligence and shop various lenders against the preferred lender. Reputable builders will not change the deal on you if you use a different lender.

  10. This is a conundrum. Who should get the deposit? While the new home buyer does not want to lose their earnest money, the builder doesn’t want to build a home specifically for a home buyer without some collateral. It seems reasonable for the builder to receive some sort of liquidated damages for the buyer’s failure to perform.

    Now, if the buyer used a preferred lender of the builder, then this can all be squared away at the very beginning of the process. The builder’s lender should be honest with the buyer and builder about one’s chances of obtaining a loan. If the buyer is borderline, then the buyer should be able to make an informed decision upfront about this matter; this is just one of the many reasons why a buyer needs their own representative — whether it’s a buyer’s agent or a buyer’s attorney to advise them about possible problems moving forward.

Leave a Reply