Earnest Money: What It Is and How It Works

Earnest Money and How it Works

If you are a first-time homebuyer, the parlance used by agents, brokers, and lenders can seem like a language unto itself. It can be quite intimidating, as purchasing a home is expensive and there is a lot to navigate.

In this blog, we’re going to explore earnest money, what it is, and how it can protect both the buyer and the seller during a real estate transaction. 

What is Earnest Money?

Earnest money serves a few different purposes. If you find a home that you are interested in purchasing, putting down earnest money acts as a good faith deposit. It shows the seller that you are serious about the purchase and aren’t wasting anyone’s time. After all, if the seller is taking the property off of the market, then no one else is going to be able to make an offer. The earnest money essentially reserves the property for the buyer while reassuring the seller that it is safe to take the property off of the market.

If the sale goes through, the earnest money is generally used as a downpayment on the home, or is put toward closing costs. 

How Much Earnest Money Should be Deposited?

The amount of earnest money that a prospective homebuyer puts down is negotiated between you and the seller. Typically, the earnest deposit will be from 1-3% of the value of the home. However, in highly competitive markets, that amount could be upwards of 10%. The more demand there is for the property, the more the seller can ask for a good faith deposit. When there is a lot of interest from potential buyers, the seller may fix the earnest money needed at a rate to weed out people who aren’t serious about purchasing the home. 

By far the best way to determine an appropriate earnest deposit would be to speak to a real estate professional. Too little and you might not be taken seriously; too much and you might be leaving yourself open to financial risks. Sometimes, real estate purchases can take longer than expected. There’s no reason to have a lot of money tied up in a real estate deal when it isn’t necessary. Usually, the odds of you losing your earnest money are very low. 

When is the Earnest Money Deposited?

After offers and counteroffers have been made, accepted and a purchase contract has been signed, the earnest money should be deposited into an escrow account within 1 to 2 days. You should make sure that your earnest money is ready to go before you start looking at homes so that you are prepared when you find the home you want to buy. If you aren’t prepared, there is nothing to stop another buyer from swooping in and buying your dream home. 

The earnest money being held in the escrow account isn’t accessible to the seller. During the time the funds are held in escrow, appraisers and inspectors will examine the property to determine its actual value and condition. 

The earnest money is payable to the escrow account via personal check, certified check, or wire transfer. 

Are Earnest Money Deposits Refundable? 

Sometimes deals fall through. You think you’re a month away from moving into your dream home when the inspector notifies you that there is serious damage to the building’s foundation. The repairs will cost a fortune, but the seller isn’t willing to budge on the asking price. Don’t worry. Even though things didn’t turn out the way that you had hoped, it doesn’t mean you have to forfeit the earnest money. 

Seller terminates sale. There are a number of reasons that real estate deals fall through where you are still eligible to have your earnest money refunded back to you — if the seller cancels the sale without a valid reason, for instance. But it doesn’t always have to fall on the seller. 

Financing. If you were unable to secure financing to purchase the home, you are eligible to have your earnest money refunded. 

Appraisal. Should the house be appraised lower than the asking price and the seller is unwilling to renegotiate the price, you will be able to have your earnest money refunded. 

Serious defects. If the house isn’t structurally sound — foundation damage, rot from flooding, roof damage — you will be entitled to a refund.

Unable to sell previous home. If you are unable to sell your current home before closing on the new one, you are entitled to a refund. 

It’s rare when a buyer is unable to recoup their earnest money when a sale falls through. That being said, there are a few circumstances in which you might forfeit your good faith deposit. 

You change your mind. Depending on the details of the contract you have signed, changing your mind about the purchase well into the sales process does not entitle you to a refund.

Waiving contract contingencies. You should never waive any contract contingencies. It is highly unlikely that your agent will ever suggest that you do so. Waiving your contract contingencies is, in essence, throwing your rights to a refund away. They are there to protect you and the seller. 

Breach of contract. If the deadline to close the sale has come and gone, you are in breach of contract. While you might not lose the house, you can lose your right to an earnest money refund. 

Protecting Your Earnest Money

Contractual obligations. Protecting your earnest money is easy. All it takes is fulfilling your contractual obligations — meeting deadlines, answering questions honestly, and providing requested documents. 

Contingencies. The most effective way to protect your earnest money is to work with your agent to make certain your contract contains the contingencies and clauses you need in case things don’t go to plan. Don’t sign anything until you and your agent have gone over the contract to ensure everything is as it should be. 

Escrow. Escrow accounts act as a third party that accepts, holds, and distributes funds or property in accordance with agreements reached by the transacting parties. Escrow is a great way to keep your funds safe. Never hand money over directly to the seller or their representative(s). 

How May The Home Loan Expert be of Service?

We have decades of experience in the mortgage industry and have helped to take the process of finding a mortgage out of the hands of faceless lending institutions and placed it in the hands of caring, dedicated professionals. 

We will work tirelessly on your behalf to ensure your mortgage is in keeping with all of your needs and goals. If you would like to learn more about us and what we can do to help facilitate your real estate purchase, please contact us. We’re happy to help.


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