What Is The Earnest Money (Also Known As Good-Faith Deposit)? Do I Get Earnest Money Back? Who Holds Earnest Money?
Are you ready to make an offer on a home purchase? If so, you may want to prove to a seller that you’re serious about the offer with earnest money.
In this article, we will take a look at what earnest money is, how to use it to increase your odds of purchasing your next home, and entities that can hold onto this money to protect your investment.
What Is Earnest Money?
Earnest money is an amount of money that a buyer puts down to show their intent to purchase a home. Also known as a good faith deposit, this money acts as a hold for the property to show that the buyer has the funds and is serious about finalizing the transaction.
Once a buyer and seller enter into a real estate contract, the seller will take the home off the market while their transaction moves towards closing. If the deal falls through for whatever reason, the seller will have to relist the property – which extends how long the property will be on the market, how much the property can go for, and other drawbacks
How Much Money is Required for Earnest Money?
Besides reassuring the seller about the buyers intent, the purpose of earnest money is to protect the seller if the buyer decides to back out of the transaction. Earnest money also decreases the likelihood that the seller is considering other properties and may withdraw the offer if they go with another seller’s property.
Typically, the amount of earnest money is 1 - 3% of the sale price of the home. For example, if a home is worth $300,000, the earnest money deposit will be somewhere between $3000 to $9000 and held in an escrow account until the deal is completed.
Once the earnest money is deposited into escrow, there are a few outcomes for this money:
- The money is returned to the buyer due to the home not meeting the contingencies listed in the contract (see below for more on contingencies).
- The money is credited against the final closing price of the home.
- The seller receives the cash as compensation for a buyer withdrawing their offer.
Should You Pay Earnest Money? As stated before, earnest money acts as an added insurance for both parties in the transaction. This lowers the overall risk for both the buyer and the seller.
It should also be stated that earnest money is not always a requirement for purchasing properties. However, it may be a necessity in a competitive real estate market with multiple buyers looking to edge one another out for a property.
Another key advantage of earnest money is in the lower the amount buyers need to provide at closing, as earnest money is applied directly to closing costs or a down payment. In essence, buyers who provide earnest money are simply putting up money earlier in the process.
Getting Your My Earnest Money Back
Buyers should know that earnest money is refundable due to contingencies depending on the situation that occurs during the real estate transaction.
Contingencies are included in the purchase agreement estate contract between the buyer and seller that states how earnest money will be distributed based on the home and transactions meeting certain criteria.
These criteria typically fall under the following contingencies:
- Home inspection contingency
- Appraisal contingency
- Financing contingency
- Contingency for selling an existing property
Home Inspection Contingency
One of the most common contingencies is whether a sellers home satisfactorily passes a home inspection. If a home inspection is performed and reveals that substantial necessary repairs are required, the buyer may have the option to back out of the transaction and receive their earnest money back. This contingency also promised a seller to make these necessary repairs to put the home in a good condition for sale or lower the price to accommodate these repairs that the buyer would perform in the future.
The appraisal contingency protects the buyer if the property is overvalued. In this scenario, a lender will usually hire a third-party appraiser to determine the fair market value of the home and compare it to two similar properties in the local area. If the appraisal shows the home is worth less than what is being sold for, the buyer can choose to not move forward with the deal and receive the earnest money back.
If a buyer wasn’t preapproved for a mortgage when they put down an earnest money deposit, and it turns out that a lender won’t approve the mortgage, this contingency contingency enables the buyer to walk away without losing their earnest money deposit.
Contingency For Selling An Existing Home
If a homebuyer is in the process of selling their own property, it is wise to have a contingency for selling an existing home to protect an earnest money deposit. If the buyer cannot sell their home before closing on a particular home sale, the buyer will receive their money back.
An Important Note About Contingencies
In competitive real estate markets, some buyers may feel pressured to waive these contingencies to make a more attractive offer to a seller. For example, they may consider waiving the financing contingency if they are a cash buyer or are fairly certain that a lender will approve a mortgage for the sellers property. Of course, these contingencies are mainly designed to protect the buyer, so having too many contingencies may turn off sellers that have multiple offers without these contingencies included in the purchase contract.
Who Holds the Earnest Money?
A buyer that intends to put down earnest money should use an escrow company or a title company to hold these funds until the contingencies are met. These companies charge a small fee to hold the money, formally put the agreement in writing, and disperse it when the contingencies are met.
Buyers who want to protect their earnest money should avoid giving the money directly to a seller. A seller who receives a cash deposit without a third-party holding the money may end up in a sticky situation, where a seller may use the money outside its intended purpose. In this case, it may be difficult to receive the money back in a timely manner or without pursuing litigation.