Buying a home is one of the most expensive purchases you are ever likely to make. Most mortgage companies require buyers to make a down payment between 3.5% and 5% in addition to paying their own closing costs. However, before you even get that far in the buying process, you will need to make an earnest money deposit.
An earnest money deposit is essentially a good faith deposit and is used to show the seller that you are a serious buyer and that you are committed to the purchase. Earnest money is different from a down payment and often a lot less.
WHAT IS EARNEST MONEY?
Depositing earnest money is an important part of the home-buying process as it tells the seller that you are in earnest as a buyer. The earnest money check is typically cashed and held in a title company trust account, or in the broker’s escrow account and it helps fund your down payment.
The earnest money requirement prevents a real estate buyer from making offers on many homes since the offer essentially takes the property off the market until they decided which one they liked best. Sellers rarely accept offers without the buyers putting down earnest money to show that they are serious and are making the offer in good faith.
Assuming that all goes well and the buyer’s good-faith offer is accepted by the seller, the earnest money funds go toward the down payment and closing costs. In effect, earnest money is just paying more of the down payment and closing costs upfront. In many circumstances, buyers can get most of the earnest money back if they discover something they don’t like about the home.
Breaking out the checkbook and presenting an earnest money check to the seller shows that you’re a serious buyer making a serious offer. An earnest money deposit shows a seller that you have both the resources and the desire to follow through with the purchase. An ample deposit may also elevate your offer to the top of the list of potential buyers.
Earnest money gives sellers monetary assurance that a buyer will not back out of the contract without valid cause. Most contracts have contingencies that allow buyers to walk away from a home. For example, if the house cannot pass inspection or the buyer cannot qualify for financing. However, if the buyer simply decides to cancel the contract for a reason not covered by a contract contingency, earnest money is generally forfeited to the seller.
HOW MUCH SHOULD THE EARNEST MONEY DEPOSIT BE?
The earnest money amount will vary depending on the price of home, the area the property is located in and even the seller’s requirements. Your earnest money deposit could range anywhere from a couple hundred dollars to a few thousand. So much depends on the specific property, the competitiveness of the market and other market-specific factors.
A competitive market might mean you will need to put down more money. Most agents agree that buyers should include an earnest money amount that will be taken seriously, but not so much that a buyer’s finances are at risk. While it is unlikely that you will lose your earnest money deposit, you still want to protect yourself.
Never give the earnest money to the seller; it could be difficult or impossible to get it back if something goes wrong. The earnest money funds are held in an escrow account until the home sale is in the final stages. Once everything is ready, the funds are released from escrow and applied to your down payment.
HOW TO KEEP YOUR EARNEST MONEY
There are a number of ways to lose your earnest money, but the key to keeping it is in knowing the related deadlines and adding contingencies. Contingencies allow you to build “get-out” clauses into the deal. Many unforeseen events can arise during the closure process. While you might not have any idea what they are, a contingency protects you against them.
Some Contingencies Include:
- Inability to get financing
- Property fails inspection
- Title search issues
- Unable to appraise home
Never give up your right to cancel your purchase until you are 100% certain that you are going to be able to close. Before adding or removing any contingencies, discuss the matter with your real estate agent and maybe even an attorney.
It is also important to know your contract deadlines. Earnest money will usually have a deadline attached to it. It should be enough time for the deal to complete (two to three months). If for whatever reason, the deal is taking longer to close and you are coming up on the deadline, negotiate a new earnest money deadline with the buyer.
If the buyer insists on keeping the current deadline, you are taking a gamble. You might go past the deadline and lock-in the earnest money only to have the deadline fall through. This could result in a loss of the house and the earnest money deposit. Be sure to be aware of the risks.
CAN EARNEST MONEY BE REFUNDED?
If the deal falls through, a small cancellation fee is usually taken out of your earnest money deposit, but the remainder remains in escrow. Whoever holds the deposit determines whether you should get the earnest money back under the terms of the purchase and sale contract. Make sure that the purchase agreement covers how an earnest money deposit refund is handled.
To be on the safe side, make sure the purchase agreement contains contingency addendums that stipulate how a refund is handled. Buyers can also usually get their earnest money back if they find problems with the property, or if they are unable to get financing. A financing contingency ensures that the earnest money is refundable and the buyer can get out of the transaction if he cannot get financing.
Keep in mind that a pre-approval from a lender does not guarantee a borrower can get a loan at mortgage rates he can afford. Even if a buyer has a good credit score and is pre-approved for a mortgage loan, the lender can still deny the borrower based on unforeseen factors such as the appraisal amount being too low. In such cases, a standard contingency allows buyers to renegotiate the purchase contract, or get their money back.
The last thing any home buyer ever wants to do is put down money to buy a home and lose it, but it happens. There are many ways to lose your earnest money deposit. If you don’t understand how your deposit is handled, you should ask questions at the time you make an offer. Ask to see the verbiage in the contract that guarantees the return of your deposit. Not every purchase contract affords this type of protection.
When choosing an escrow company there can be many important factors to evaluate. Fees, location, staff and even recommendations from friends and colleagues are all things to consider. With Citrus Heritage Escrow by your side, you can rest assured that when you receive your settlement check, you’ve gained the maximum benefit from your home sale or purchase.
Call us today with any questions or concerns. Our professional Escrow Agents will help you through this exciting yet confusing process. (951) 335-7200