Okay, here's the deal. We were buying a house and had 10 days from the date of acceptance to get a home inspection completed and a repair request back to them - or walk away. The guy came out and uncovered a drainage issue and referred us to another professional to come look at it. He came a couple of days later, but he still wasn't the right person(he was a concrete guy, said we really needed an escavator). Meanwhile, we are approaching the 10 day mark so we asked for an extension for an additional 5 days. The realtor acknowledged receiving it, but didn't have the owner sign it until 3 days later - don't know if that's an issue - but he didn't refuse it, he agreed to it. Anyway, A couple of days later, an escavator came out and did his thing and after he got done explaining everything to us, we just felt really uncomfortable with the situation. So - we submitted a release of contract the next day, 2 days before the extension deadline. I understand that he was unhappy with it - especially considering that his house had been marked pending and we had essentially screwed around for @ 15 days. But we are still in the right aren't we, because we are still within the appropriate timeframe to walk away per our contract. My realtor is pretty green and is worried about it and the sellers have consulted an attorney. Is there any way they can keep our $3500?? I don't see how. Oh, and we're obviously out a $400 home inspection and $50 termite fee - which uncovered this drainage issue - which WAS NOT DISCLOSED ON THE DISCLOSURES AT ALL. Please let me know what you think....

Impossible to answer without seeing the purchase agreement wording. I suggest that you get the purchase agreement and consult an attorney. The realtor may be upset, but that is not your problem. You may have to sue for the earnest money back even though you likely are entitled to it, so be prepared.