Content of the material
- What Is an Earnest Money Deposit?
- Earnest Money Deposit
- What Is Earnest Money Used for?
- Why Should You Pay Earnest Money?
- How Verified Approval Could Help
- Paying earnest money deposit
- How to Protect Your Earnest Money Deposit
- How Do I Ensure My Earnest Money Is Refundable?
- Common Earnest Money Contingencies
- How much money is needed for the earnest deposit?
- How Are Deposits Paid?
- Understanding Earnest Money
- About Homes for Heroes®
- What to Do First in a Dispute Over Earnest Money
- You’re now leaving Chase
What Is an Earnest Money Deposit?
Earnest money is a good faith deposit that is part of the down payment, but it is not the same as a down payment. It is like the buyer saying to the seller, “Yes, I am serious enough about buying your house that I’m willing to put my money where my mouth is.”
When a purchase contract is executed, it specifies how much money the buyer is initially putting down to secure the contract—the earnest money deposit—and how much money will ultimately be deposited as a down payment. The down payment is a portion of the home's sale price paid upfront rather than financed as part of the mortgage.
Earnest Money Deposit
A seller can gauge your willingness and ability to buy the home by the strength of your earnest money deposit. Real estate contracts include a clause for deposits. Contracts specify the amount you must deposit and the date by which you must deliver the money to the escrow holder. They also may specify the method by which you plan to deposit funds — electronically or by check. Negotiations between buyer and seller determine the specifics, however, a typical deposit equals 1 percent to 2 percent of the purchase price.
What Is Earnest Money Used for?
In real estate, earnest money is effectively a deposit to buy a home. Usually, it ranges between 1-10% of the home’s sale price. While earnest money doesn’t obligate a buyer to purchase a home, it does require the seller to take the property off of the market during the appraisal process. Earnest money is deposited to represent good faith in purchasing the home.
Why Should You Pay Earnest Money?
Earnest money isn’t always a requirement, but it could be a necessity if you’re shopping in a competitive real estate market. Sellers tend to favor these good faith deposits because they want to ensure that the sale won’t fall through. Earnest money can act as added insurance for both parties in the transaction.
Earnest money could also lower the amount you need at closing because it’s applied directly to your down payment or closing costs. Essentially, you’re just putting up some of the money earlier in the process.
How Verified Approval Could Help
Rocket Mortgage’s Verified Approval can give you even more of a leg up on the competition by assuring the seller that you can qualify for the loan you need. A seller looking at multiple offers is more likely to lean toward a buyer with approved funding – and having earnest money down on top of it can make your offer stand out even more.
Paying earnest money deposit
Typically, you pay earnest money to an escrow account or trust under a third-party like a legal firm, real estate broker or title company. Acceptable payment methods include personal check, certified check and wire transfer.
The funds remain in the trust or escrow account until closing. That’s when they get applied to the buyer’s down payment or closing costs. Alternatively, you can receive your earnest money back after closing.
How to Protect Your Earnest Money Deposit
When making an offer and submitting your earnest money deposit, it pays to be informed. While issues are rare, be sure you give the deposit to a trusted party. If anything seems fishy, talk to a trusted advisor. It's important to protect yourself and your money from potential scams.
In order to protect your earnest money deposit, keep the following tips in mind:
- Never give an earnest money deposit directly to the seller.
- Make the deposit payable to a reputable third party, such as a well-known and established real estate brokerage, legal firm, escrow company, or title company.
- Verify that the third party will deposit the funds into a separately maintained escrow account.
- Obtain a receipt.
- In general, don’t authorize a release of your earnest money until your transaction closes.
How Do I Ensure My Earnest Money Is Refundable?
If you don’t end up closing on the mortgage, you can potentially end up losing your deposit. However, there are also certain ways to increase your odds of getting it back.
Common Earnest Money Contingencies
The only way to guarantee you’ll get your earnest money deposit back from escrow under a given scenario is to have a contingency in your purchase agreement. There are several types of contingencies you can use to try and protect your deposit:
- Home inspection contingency: You can write into your purchase agreement that you get your deposit back if something specific comes up in the home inspection. This clause is generally limited to major issues like a home needing a new roof or an HVAC system.
- Appraisal contingency: An appraisal contingency gets you your deposit back if the home doesn’t appraise for the purchase price, which is important because the lender can’t give you more than the house is worth. It may not get this far, as sellers may be willing to go back to the negotiation table with you at this point to make the transaction workable, though that’s not always the case.
- Financing contingency: If you had this contingency included in your agreement, you can get your deposit back if your mortgage financing falls through.
- Existing home sale contingency: If you’re trying to sell your current home while buying your new one, you may negotiate to have the purchase contingent on the sale of your prior home so that you don’t have to make two mortgage payments.
Purchase agreements are negotiations. Not every contingency is going to be agreed to by the seller in many cases. Sellers who are particularly motivated to sell their home may balk at someone asking for too many contingencies in the purchase agreement, but it’s understandable to want some protection. It’s a balance. The bottom line is that you should be aware of the terms of your purchase agreement so that you know when you can and can’t get your money back.
How much money is needed for the earnest deposit?
The seller will want higher amounts to ensure buyers don’t back out, and in fact, it can help make a stronger offer. However, lower sums of money present less of a risk to the buyer and can make it easier to purchase.
The amount of earnest money deposit will often depend on what is normal locally and can be influenced by how in-demand housing is in the area.
More significant deposits are often required when there are a lot of buyers, and this could go up as high as 10 percent of the purchase price if the property is new construction. Usually, though, the earnest money will range from 1-5 percent of the price.
When you reach closing on the house, the earnest money will be used to pay the buyer’s closing costs or contribute to the purchase price of the home. It is crucial for an agent to be aware of what money the buyer needs to have and when it needs to be paid to keep the deal on track.
This will give you and the buyer a better chance of a smooth and trouble-free purchasing process.
How Are Deposits Paid?
Whether deposits are delivered all at once or broken into two phases, they typically must be delivered via cashier’s check or wire. Personal checks are rarely accepted.
Deposits aren’t held by the seller. They are held by the escrow company or attorney handling the settlement for transaction. Your real estate agent can advise whether you’re in a state that settles home purchases using escrow companies or attorneys.
Understanding Earnest Money
In most cases, earnest money is delivered when the sales contract or purchase agreement is signed, but it can also be attached to the offer. Once deposited, the funds are typically held in an escrow account until closing, at which time the deposit is applied to the buyer’s down payment and closing costs.
When a buyer decides to purchase a home from a seller, both parties enter into a contract. The contract doesn’t obligate the buyer to purchase the home, because reports from the home appraisal and inspection may later reveal problems with the house. The contract does, however, ensure the seller takes the house off the market while it’s inspected and appraised. To prove the buyer’s offer to purchase the property is made in good faith, the buyer makes an earnest money deposit (EMD).
The buyer might be able to reclaim the earnest money deposit if something that was specified ahead of time in the contract goes wrong. For instance, the earnest money would be returned if the house doesn't appraise for the sales price or the inspection reveals a serious defect—provided these contingencies are listed in the contract.
However, earnest money isn’t always refundable. For example, the seller gets to keep the earnest money if the buyer decides not to go through with the home purchase for contingencies not listed in the contract or if the buyer fails to meet the timeline outlined in the contract. The buyer forfeits the earnest money deposit if they simply have a change of heart and decide not to buy.
Earnest money is always returned to the buyer if the seller terminates the deal.
While the buyer and seller can negotiate the earnest money deposit, it often ranges between 1% and 2% of the home's purchase price, depending on the market. In hot housing markets, the earnest money deposit might range between 5% and 10% of a property's sale price.
While the earnest money deposit is often a percentage of the sales price, some sellers prefer a fixed amount, such as $5,000 or $10,000. Of course, the higher the earnest money amount, the more serious the seller is likely to consider the buyer. Therefore, a buyer should offer a high enough earnest deposit to be accepted, but not one so high as to put extra money at risk.
Earnest money is usually paid by certified check, personal check, or a wire transfer into a trust or escrow account that is held by a real estate brokerage, legal firm, or title company. The funds are held in the account until closing, when they are applied toward the buyer’s down payment and closing costs. It’s important to note that escrow accounts, like any other bank account, can earn interest. If the earnest funds in the escrow account earn interest of more than $600, the buyer must fill out tax form W-9 with the IRS to receive the interest.
Those interested in learning more about earnest money may want to consider enrolling in one of the best online real estate schools.
Prospective buyers forfeit their earnest money if they decide to back out of a purchase.
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What to Do First in a Dispute Over Earnest Money
The purchase contract is the first resource to consult when a dispute has arisen over whether earnest money should be returned to the buyer. The terms of the contract will govern the parties’ next steps. Often, the contract or state law will require that the parties attend mediation or arbitration before anyone can bring a suit to recover the money.
The home buyer and seller should also consult with the entity or person holding the earnest money and inquire as to what its procedure is in the event of a dispute. Most likely, the escrow holder will have a standard procedure or at least some advice about what happens next. Many states have specific, systematic laws about how escrow holders must handle disputes over earnest money. Parties to a dispute will need to become familiar with these laws.
It’s also a good idea to consult with an attorney about your escrow money dispute, especially one who is good at negotiations. Almost no one is going to want to take the matter to court—it is probably in everyone’s best interest to at least explore the possibility that there has been a misunderstanding or that a compromise can be reached.
Whether you are a buyer or a seller in a dispute over earnest money, keep in mind what the purpose of the earnest money is to the other side: for the buyer, the money was put forward to secure a right to purchase and show good faith. For the seller, the money was put forward so as to be assured of compensation for any time lost by taking the property off the market for the benefit of the buyer.
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