First time home buyers often confuse a down payment with an earnest money deposit. Although they are similar, they are not the same.
What is earnest money?
Earnest money is a deposit made by the buyer to let the seller know they seriously intend to purchase the house. This deposit helps the buyer acquire more time to get things in order such as inspections, appraisals, and title searches before the actual closing date. This money is usually put down at the signing of the purchase agreement, where the funds are held in an escrow account. Once the deal is closed, these funds are applied to the buyer’s closing costs or down payment.
Why pay earnest money
Just because a buyer signs a purchase agreement does not guarantee that they will purchase the home. Home inspections or appraisals can reveal issues that may deter somebody from going through with a purchase. However, purchase agreements require the seller to take the property off the market while the appraisal and inspection are taking place. To help ensure the buyer’s intentions of purchasing, an earnest money deposit is made.
Refunding earnest money
Earnest money may be refunded if contingencies in the purchase agreement are not met. For example, if a property is valued at less than the sale price, chances are the earnest money will be returned to the buyer. This isn’t always the case though. If the buyer decides to not purchase the property, for reasons not listed in the purchase agreement, the earnest money will not be returned. Earnest money is almost always refunded if the seller decides to not go through.
How much earnest money is acceptable?
Earnest money is negotiated by the buyer and seller, but is typically between 1%-3% of the purchase price. The current state of your housing market can affect the amount of earnest money needed. In a hotter market, the earnest money amount could be between 5%-10% of the purchase price. The more earnest money put down, the more serious the buyer is to be taken. Some sellers even require a fixed price for earnest money. Buyers need to be able to put enough money down to secure the property, but not so much as to risk losing the money.
Playing it safe with earnest money
There are a few measures a buyer can take to help ensure that their earnest money is safe.
- Make sure there are contingencies that will protect the money regarding inspections and financing.
- Understand and abide by the terms and deadlines of the purchase agreement.
- Make sure the money is handled by a reputable 3rd party and keep all related documents and receipts.
Removing contingencies can be a great way for a buyer to gain leverage when negotiating. Consult your real estate agent before removing any contingencies. You don’t want to give anything up until you’re completely certain that you can close.