Are you ready to make an offer on your dream home? With how competitive the housing market is, it’s more important than ever to show the seller you’re a serious buyer. Stand out from other applicants with your secret weapon: earnest money.
But how does earnest money work anyway and how can it help you land the house you want? In this guide, we’ll take a close look at earnest money, why it’s beneficial when buying property, and how to protect your investment. Use the links below to find exactly what you’re looking for.
- What Is Earnest Money?
- Why Should You Pay Earnest Money?
- How Much is Enough?
- Can I Get My Earnest Money Back?
- Protecting your Earnest Money Deposit
What is Earnest Money?
Earnest money is a real estate term that refers to the money you put down before closing to show that you’re serious about your purchase. You may hear others call this a good faith deposit.
You can think of earnest money agreements like engagement rings. Let us explain. When you make an earnest money deposit, you’re essentially proposing to the seller and showing your commitment to seeing your investment through, which they can either accept or deny. If it’s accepted, you won’t own the home just yet; you’re simply “engaged” during this period. Earnest money will give you extra wiggle room to get financing, inspect the home, and conduct property appraisals.
The money you offer will be held in an escrow account, typically paid by wire transfer, personal check, or certified check, until a deal is reached. The account will usually be managed by a legal firm, real estate brokerage, or title company. If neither party backs out, these funds will be used to help cover your down payment or closing fees. If you’ve been wondering what’s the difference between earnest money vs a down payment, this is key.
Why Should You Pay Earnest Money?
As a buyer, you won’t be able to make offers on other homes if the seller accepts the earnest money. This ensures the seller that you won’t back out of the deal. If you do back out, the seller has to put the property back on the market and meet with buyers again. Earnest money protects the seller and yourself from losing money and wasting time. Think of this as a way to ensure your purchase.
Although earnest money in real estate may not be required, it’s a good idea if you have your heart set on a certain home. It can make all the difference, especially in a competitive market. Moreover, the money won’t be in vain because it’ll be used for the down payment and closing costs.
How Much is Enough?
Now that we’ve covered the foundation of earnest money, how do you know how much is enough? The amount you offer will greatly depend on the location you’re buying real estate in. For instance, if the house you want to buy is in a highly competitive area, then a higher earnest money deposit may be a good idea. On the other hand, if you’re looking at properties in an area that isn’t selling quite as fast, you may be able to get by with a smaller deposit.
An experienced real estate agent can help guide you in the right direction when it’s time to make an earnest money proposal. You want to make a strong offer that the seller won’t be able to deny. The amount can range anywhere between 1-5% of the sales price. If there’s fierce competition, you may have to go higher—10% or more of a home’s purchase price.
Additionally, there are sellers out there that may ask for a fixed monetary sum, for instance, $1,000 or even $5,000. Needless to say, it’s not always easy to come up with this money on top of paying for a professional home inspection, down payment, and fees. It might be tempting to skip it altogether since it’s often optional, but it could be worth doing so if you’re enamoured with a property. Seeking financing for an earnest loan may help you latch on quickly to your dream home.
Can I Get My Earnest Money Back?
Fortunately, earnest money is protected by certain contingencies. As mentioned, an earnest money deposit will essentially lock in the deal and prevent yourself and the seller from backing out. However, there are ways to get out of the deal without losing money.
If your offer is approved, you’re guaranteed a sale only when these contingencies and criteria are met. Here are three contingencies that are often covered per the purchase agreement.
Home Inspection Contingency
A home inspector could come to you with big and small repairs that need to be made. If this is the case, you’re allowed to exit the negotiation without penalty. If you’ve set your eyes on the home, however, you can also work with the seller to cut back the price of the property or ensure they make the necessary repairs before closing.
From divorce to unemployment and even life-changing accidents, anything can happen, which could have a significant impact on your mortgage approval. Whatever the circumstance may be, your financial situation could drastically change, and your mortgage could, unfortunately, be denied. If you don’t have a way to finance the property, you may be able to walk away with your earnest money. The mortgage contingency must be included in your agreement for it to be valid.
An appraisal contingency will ensure that the home you’re buying is priced fairly. The appraisal process is handled by the lender, who will hire a third-party appraiser to determine the value of the property. If its sale price is higher than the actual value of the home, you can get your earnest money back or negotiate a more reasonable price.
It’s important to note that you may not always get your money back. If there’s a contingency not listed on your purchasing contract and you no longer want to buy, then the money will go to the seller. This can also occur if you don’t meet the timeline found on your purchase agreement. However, rest assured that you’ll always get a refund if the seller changes their mind.
Protecting your Earnest Money Deposit
Like any investment, you must secure it so you don’t face financial losses. Here are a few ways to keep your earnest money protected:
Use a Reputable Company
An escrow account will prevent you from directly giving the funds to the seller. Instead, you’ll make the payment to a reputable third-party escrow company, so they hold the money for you. Once you close, the money will be released and can be used toward your down payment or to cover closing costs. Ensure you have a copy of the receipt and verify the amount once it’s time to close.
Understand the Contingencies
Make sure you know which contingencies are in your property agreement so you can leverage them if necessary. Knowing the details of each potential contingency of the deal will ensure that you can get your money back if you back out.
Know Your Responsibilities
It’s important to stay on top of your responsibilities if you don’t want to lose the home. The purchase agreement will often include deadlines for your inspection or mortgage approval. Remember, you made an earnest money deposit to appear as a serious buyer. Don’t let missing deadlines come between you and your dream home.
Keep Track of Everything
It’s vital you make sure every agreement discussed between you and the seller is on paper, so you can refer to it should anything happen. The purchase agreement should outline the specifics, including what the earnest money will be used toward and who it’ll go to if either party walks away from the deal. For instance, your contract could state the seller will receive the money if you decide you no longer want to move forward with the purchase. Be as detailed as you possibly can to prevent misinterpretations.
Protect yourself and your money from scammers by following the tips above. The home buying process is exciting, but it can also be riddled with con artists looking to run with your hard-earned cash.
The Bottom Line
Buying a home a is a big commitment and sellers want to see that you’re ready for it. While an earnest money deposit may often be optional, it can help you secure a deal on your dream home—especially if you want to live in a location with a highly competitive real estate market.
Whether it’s your first time buying a home or are looking for more home buying tips, check out real estate and home buying blogs.