What is earnest money deposit & how much is enough?
Go Back To Previous PageEarnest money is a deposit the buyer makes to show their genuine intent to purchase a property. It demonstrates to the seller that the buyer is serious about their offer. If you have found your dream home and are ready to make an offer, providing an earnest money deposit is an effective way to prove your commitment. This deposit ensures that the seller takes your offer seriously.
This guide will explain earnest money, why it is essential, how it can be advantageous when buying a home, and how to protect your deposit if the deal falls through and you cannot close.
What Is Earnest Money?
Earnest money is a deposit buyers make when they sign a purchase agreement. This deposit is typically due when the contract is signed, but can accompany an initial offer. The earnest money deposit aims to demonstrate the buyer’s seriousness and protect the seller if the buyer returns from the deal without a valid reason.
Depositing earnest money makes real estate transactions more likely to close successfully because it discourages buyers from shopping around or making offers on other homes once they have
signed a purchase agreement.
Real estate agents often abbreviate earnest money deposit (EMD); some may consider it a good-faith deposit.
How Does Earnest Money Work?
Once the buyer and the seller sign a purchase agreement, the seller will remove the property from the market.
The closing process can take some time because the buyer must complete a due diligence process that includes inspecting the home. Additionally, the buyer will need to secure financing and finalize a mortgage loan.
Most sellers expect buyers to provide a sum of money held in escrow in exchange for removing the house from the market.
A third party, often the seller’s attorney, typically manages this deposit. The attorneys will apply the earnest money deposit to the purchase price if everything proceeds smoothly.
If financing does not come through or if a negative home inspection causes the deal to fall through, the buyer can retrieve their earnest money deposit. This is contingent on the purchase agreement containing the appropriate contingencies.
How Much Is An Earnest Money Deposit?
Generally, the money deposited typically ranges from 1% to 10% of the purchase price. The exact amount can vary based on your local market and, in some cases, may be as high as 10%. If you are working with a real estate agent, they can provide guidance on what is appropriate for your area.
In a booming real estate market, you might need to put down a larger earnest money deposit, while in a slower market, a deposit of just 1% may suffice.
Is Earnest Money Refundable?
The amount of earnest money is typically refundable, and the terms for this will be specified in the contract. The earnest money agreement should include contingencies that protect both the seller and the buyer. The most common contingencies are financing and home inspection contingencies.
Essentially, even if the seller has accepted your offer, the sale will only be finalized once all contingencies outlined in the purchase agreement are satisfied.
Earnest Money Contract & Contingencies
The earnest money contract should include various contingencies or requirements that must be fulfilled for the sale to proceed to ensure protection for both parties.
Below you will find information on the most common contingencies.
1) Financing Contingency Clause
If you plan to get a mortgage, including a financing contingency in your agreement is crucial. Even if you are preapproved, there’s still a chance that your financing could fall through.
You don’t want to risk losing your earnest money deposit in such a situation, so having this contingency is important.
2) Home Inspection Contingency
A common concern for many buyers is the home inspection. No one wants to purchase a home only to discover they must spend tens of thousands of dollars on a new roof or repairing foundation cracks.
A home inspection contingency can protect buyers and provide a way to withdraw from the deal if the property receives a negative inspection report. With this contingency, you can retrieve your earnest money if the inspection is unsatisfactory.
3) Other Common Contingencies
Contracts can include various conditions or contingencies, with the appraisal contingency being one of the most common. This allows the buyer to back out of the deal if the home appraises for less than the agreed sales price.
Another common type of contingency relates to the sale of the buyer’s existing home.
Buyers must address all necessary contingencies to ensure they can receive a refund of their earnest money if the transaction does not proceed as planned and they cannot close on the house.
Protecting Your Earnest Money Deposit
When purchasing a property, protecting your earnest money deposit is essential. Here are some key strategies:
- Include Contingencies: Always incorporate contingencies for financing and inspections into your contract. These protections ensure that your deposit is safe even if unexpected issues arise.
- Utilize Escrow: Ensure that a reputable third party holds your earnest money deposit in escrow rather than giving it directly to the seller. Additionally, always obtain a receipt for the deposit.
- Stay Organized: Track all deadlines and diligently follow your contract terms. For instance, if inspections must occur by a specific date, be proactive to avoid missing the deadline and potentially losing your deposit.
- By following these steps, you can better safeguard your earnest money during the property buying process.
Summary
Although earnest money may feel like an additional expense during the buying process, it is essential. It demonstrates to the seller that you are a serious and committed buyer.
Making an earnest money deposit assures sellers that you are unlikely to back out of the purchase contract simply because you changed your mind.
