Buying a home is an expensive investment. From paying appraisal fees, inspectors, and purchasing a title insurance policy, there are many closing costs to be aware of. When buying a home in a tight housing market, one cost you may have not heard of is earnest money, otherwise known as a good faith deposit. But what is earnest money and how does it work exactly?
So What is Earnest Money?
When putting an offer on a home, providing earnest money in conjunction with your offer shows the seller that you’re serious about the purchase. After receiving an earnest money deposit, the seller will take the home off of the market so that the appraisal, inspection and other steps in the closing process can take place. The deposit is paid into an escrow account and is held by a title company or by the real estate agent’s company until closing day. At closing, the earnest money will be credited to the buyer’s closing costs.
How Much is Required for an Earnest Money Deposit?
Earnest money deposits are typically a percentage of the purchase price of the home or a fixed amount. The amount required for an earnest money deposit is dependent on the market, location, and current competition.
A fixed amount will be a standard price that you pay regardless of what the price of the home is. This fixed amount will be what you submitted once the Seller accepts your purchase agreement. Whereas with percentage deposits, you will submit earnest money as a certain percentage of the home price. For example, if the common practice in your area is to submit a 5% earnest money deposit on a $400,000 home, your deposit would be $20,000. When the market is competitive, buyers may provide above-market earnest money to get the edge on the competition.
In a competitive housing market, earnest money could make you stand out.
Is Earnest Money Refundable?
Depending on the situation. Earnest money is considered liquidated damages to compensate the Seller for the time the property is off the market if the Buyer breaches the contract.
Following inspections, appraisals, and other deadlines in the closing process, the earnest money credited to the buyer’s closing costs and down payment. While this would be the desired scenario, there are times where a purchase may fall through. In order to keep your earnest money you must:
Understand your contingencies
A contingency is written into your purchase agreement and used to safeguard your deposit. There are four types of contingencies:
- Home Inspection Contingency: Allows for the buyer to receive their deposit back if major issues are revealed during the inspection.
- Appraisal Contingency: Buyers can ask for their deposit back if the home does not appraise for the purchase price as lenders will not give more money to the buyer than the home is worth.
- Financing Contingency: Buyers can receive their deposit back if financing falls through.
- Existing Home Sale Contingency: When selling your current home, buyers can include this in the purchase agreement to have the purchase dependent on when the current home is sold.
Be proactive with timelines
When it comes to real estate contracts, timelines are essential to ensure that the sale is completed in a timely manner. In most contracts, the seller will include a clause that includes a binding closing date. This means that the buyer must complete all necessary inspections, financing, and appraisals before the date. As long as you meet the deadline, your earnest money will be applied at closing.
Deposit money with a title company
When depositing a large sum of money, it is important that you take extra precautions to protect yourself. This means that you should never give money directly to the seller. In order to protect yourself, deposit your earnest money deposit into an escrow account that can be accessed at the time of closing.
While buying a home is a monumental and costly expense, it is a valuable asset that will be cherished for years to come. When serious about the purchase, earnest money is a great way to differentiate yourself in a competitive housing market.