Once you've found a house and want to make an offer, the seller's agent will ask you to put up an "earnest money" deposit, which indicates your offer is serious. Sometimes the amount requested is relatively small -- $500 or $1,000 -- but it can be much larger, as much as 2 percent to 3 percent of the offering price. You need to take steps to ensure you can get your deposit back if your mortgage application is declined.
TL;DR (Too Long; Didn't Read)
As long as you used a responsible party and your purchase agreement backs you up, you can request a refund of your deposit if your mortgage application is denied.
Use a Responsible Party
To ensure you can get your deposit back if the mortgage application is declined, only hand over the deposit to a responsible party. The holder-of-record responsible for your deposit varies from one state to another. In some states, it's the Realtor -- in others, the title company.
It's almost always a mistake to give the deposit check directly to the seller, even with a contract. If the seller refuses to return the money, your only recourse may be small-claims court. Whoever will hold the money, check their reputation online and through organizations such as the Better Business Bureau before writing the check.
Read the Purchase Agreement
An integral part of the offer is the purchase agreement, which states your offer, the deposit amount, who holds it and any rights you may have if you can't get a mortgage. If there is no provision in writing for the return of the deposit, you are unprotected. Note that you have every right to amend the contract so that it guarantees the full return of the deposit money if, through no fault of yours, you can't get a mortgage.
Verbal Guarantees and Partial Returns
Sometimes one of the parties may tell you that all you need to do to get your money back is to get a denial-of-mortgage letter from the company that turned down your application. You'll give this letter to your Realtor or escrow agent. Whatever rights you have for the return of the deposit, and whatever proof of denial you will need to provide, are stated in the purchase agreement.
If they're not in writing, you have no rights. Another issue that often comes up is the inclusion of a cancellation fee in the purchase contract. You may or may not agree to a cancellation fee. In some cases, the fee itself, or the amount of the fee, is negotiable.
Timing Does Matter
Another issue that sometimes costs buyers their deposits is the timing of the offer. The purchase agreement may state that you must either buy the house or show proof of mortgage denial before a specified time or forfeit the deposit. If the agreement contains such a provision, and the lender hasn't made a decision before your time's up, you will lose the deposit. To avoid this, insist on the removal of the time limit in the contract.
Alternatively, get a written agreement from the lender that if it fails to approve or deny the loan within the time limit, it will provide a proof of denial. It may speed the process along if you apply for pre-approval from the lending institution before you begin searching for your house. Be aware, however, that pre-approval is not an absolute guarantee that the loan will be approved.
Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.