Texas Home Buying Basics: Earnest Money and the Termination Option

Texas Home Buying Earnest Money and Termination Option

First-time home buyers in Texas may find themselves overwhelmed with unfamiliar terminology surrounding the purchase process. To protect their interests, such buyers should work to gain a basic understanding of the fundamentals of a home purchase before committing themselves to a contract. Two of the basic concepts of the typical home purchase with which every home buyer in Texas should become familiar are earnest money and the termination option.

What is Earnest Money?

Earnest money is a portion of the purchase price of a home that the buyer pays upfront after signing the purchase contract. Typical earnest money payments in Texas range from one to three percent of the overall purchase price, though the exact amount is an object of negotiation between the buyer and seller. Once paid, the earnest money is generally non-refundable upon the buyer’s termination of the contract unless a legal justification for the termination exists or the contract says otherwise. The purpose of the earnest money payment is to discourage the buyer from backing out of the contract after signing and to compensate the seller in the event of the buyer’s unjustified termination.

Rather than paying the earnest money to the seller, the buyer usually delivers the earnest money to an agreed-upon third party, the title company, who holds the earnest money for safekeeping until the sale closes or terminates. If the sale successfully closes, the title company credits the earnest money to the seller. If the sale terminates without closing, the title company releases the earnest money to either the buyer or the seller, depending on the terms of the contract and the circumstances that led to the termination. 

The title company’s release of the earnest money to the buyer or the seller is often the biggest point of contention after a sale falls apart. Many buyers find it financially unfeasible to fight a legal battle to get their earnest money back from an uncooperative seller, even if their termination of the contract was completely justified. For this reason, we caution first-time home buyers not to commit more money than they can afford to lose when putting down the earnest money for a home.  

What is the Termination Option?

A standard feature of the TREC One to Four Family Residential Contract and most other home purchase contracts in Texas, the termination option allows the buyer to pay a small non-refundable fee on top of the earnest money after signing the purchase contract. In exchange for this extra payment, the seller agrees to give the buyer a number of days following the signing of the purchase contract during which the buyer can terminate the contract for any reason and receive their earnest money back. During this “option period,” the buyer should have a general home inspection performed on the property along with any specialized inspections that the unique characteristics or history of the property may warrant (e.g. foundation, plumbing, wood-eating insects, etc.). If the inspections reveal previously unknown defects that render the home undesirable in the eyes of the buyer, the buyer can exercise their termination option and walk away from the deal, losing only the option fee and the cost of the inspections. Inspections can still be performed after the option period lapses; however, if the buyer chooses to terminate the purchase based on the results of an untimely inspection, they may forfeit their earnest money or face adverse legal action by the seller. 

The amount of the fee that the buyer pays in exchange for the termination option and the length of the option period are negotiable between the buyer and seller, and we encourage first-time buyers to bargain for as long an option period as the seller is willing to grant. Having enough time to get a thorough home inspection done while you still have the option to terminate can potentially save thousands of dollars if the house turns out to be a lemon.

Whether buying or selling a home, the assistance of an experienced Texas real estate attorney can help you navigate the ins and outs of the purchase process and ensure that your interests are protected.    

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