Earnest Money

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What is Earnest Money?

Earnest money is a payment settled by a homebuyer for a seller to prove their honest intentions of purchasing the seller's house. Also referred to as a "good faith deposit," this money is essential in hot real estate markets to show a buyer's seriousness towards buying the seller's property.

When purchasing a home, sellers will likely ask for earnest money to withdraw their houses from the real estate market. The amount of the good faith deposit is agreed upon when the seller and the buyer sign the purchase agreement.

The agreed-upon amount varies depending on several variables related to the demand for the property. If demand is high, the seller will likely ask for a high amount of earnest money since they can accept several offers.

On the other hand, if demand is low, the good faith deposit amount would likely also be low. In this case, a home seller wouldn't pressure a homebuyer since they have limited offers for the house.

Generally, the amount ranges between 1% and 3% of the property's cost in cold markets or between 5% and 10% in hot markets. It can also be a sole payment between $5,000 and $15,000.

However, it is always crucial to seek advice from real estate experts in identifying the amount of the good faith deposit.

Key Takeaways

Earnest money is a security deposit submitted by a buyer to demonstrate their commitment to purchasing a property. Once the transaction is finalized, it is generally applied toward the purchase price or closing costs.
Earnest money is a deposit made by the buyer to show serious commitment to the purchase and provide some protection to the seller in case the buyer backs out without a valid reason.
Earnest money is usually held in an escrow account managed by a neutral third party, such as a real estate brokerage, title company, or legal firm until the transaction is completed or terminated.
If the buyer defaults or cancels the contract without meeting the specified contingencies, the seller may be entitled to keep the earnest money as compensation for lost time and potential buyers.

How Earnest Money work

Home buyers pay earnest money to ensure a property is reserved for them while the property is being inspected and appraised. This money is paid right after the purchase agreement between the buyer and seller is signed.

The agreement includes:

Conditions and contingencies on purchasing the house.
The amount of the earnest money deposit.
Other information regarding deadlines and the property in general.

After signing the purchase agreement, the homebuyer deposits the amount in an escrow account. The account is payable to an independent third party called the escrow agent.

Escrow Account

An escrow account is a legal account owned by an independent legal party.

The homebuyer pays the account, but it is only payable to the escrow agent. Money in escrow accounts is released to sellers when conditions and contingencies included in purchase agreements are met.

Escrow Agent

An escrow agent is an independent mediating party between the home seller and buyer. Such agents can be title, law, or real estate firms. The buyer usually chooses them after the seller agrees.

Their main roles are conducting title research, ensuring conditions and contingencies are met in a purchase agreement, and closing the escrow account when the purchase terminates.

After paying the money, the house is inspected and appraised. Based on the results, buyers either decide to proceed with the purchase or step out of the deal.

If the purchase takes place successfully, the money will be paid to the seller and will go towards the price and the closing costs of purchasing the property.

On the other hand, if the deal fails to take place, the money in the escrow account will either be returned to the buyer or the seller, depending on the reason behind the annulment of the deal and the contract signed by both parties.

When do buyers return earnest money?

Purchase agreements include contingencies and conditions on a house purchase. If the buyer's reasons behind stepping out of the deal are backed in the agreement, the money deposited in the escrow account may be returned.

It is crucial to mention that each condition and contingency mentioned in the agreement comes with a deadline. Thus, the buyer should meet the deadlines successfully to see their deposited money returned.

Reasons buyers step out of a deal include:

Undesired inspection results: If the house is inspected before the deadline mentioned in the agreement and the results do not meet the buyer's requirements, the buyer reserves the right to withdraw from the deal and withdraw the money previously paid.
Overpriced houses: if the house's appraisal shows that it deserves less than the stated price on the purchase agreement, buyers get to keep their money and not purchase the home.
Financing difficulties: If the buyer is unable to secure the required financing to purchase the house, they get to withdraw the escrow deposit and break the deal.

Note: These conditions are mostly included in purchasing agreements with a deadline. If they are omitted, the buyer cannot withdraw their money. Also, even if they are included, but the buyer cannot meet the stated deadline, they may be subject to losing the good faith deposit.

It is important to note that when sellers decide to break the deal, the buyers will certainly withdraw their money.

When do sellers keep earnest money?

Sellers tend to keep the earnest money deposit when buyers decide to step out of the deal for reasons not mentioned in contingencies in the purchase agreement or when they fail to meet certain deadlines.

For instance, if the buyer decides to step out of the deal due to a new noisy project nearby, knowing that neighborhood conditions are not clearly stated in the purchase agreement, the seller may keep the good faith deposit.

Alternatively, even if the house does not pass inspections, the seller would keep the money if the inspection results are generated after the stated deadline on the agreement.

When the buyer does not support their claim and leaves the deal just because they have a change of heart about purchasing the house, the seller keeps the good faith deposit.

Protecting Your Earnest Money Deposit

To ensure the return of your good faith deposit, you need to take the following steps:

1. Ensure including clearly written contingencies in the contract

Make sure to include contingencies that let you out of the deal when needed. Such contingencies may include damaged or overpriced houses or the buyer's inability to raise funds to afford the house.

You need to remember that the buyer can never back their claim for leaving the deal for reasons not explicitly mentioned in the contract.

2. Take responsibility for deadlines

You need to meet the deadlines mentioned in the purchase agreement to withdraw the earnest money when you withdraw from the purchase. Thus, watch the deadlines and prepare reports to back up your claim before they pass.

Also, make sure you ask for realistic deadlines in the purchase agreement so you do not miss any.

3. Never hand the good faith deposit directly to the seller

The good faith deposit should be paid in the form of an escrow account managed by an independent party. Make sure not to give the money directly to the seller since they may refuse to hand it back in cases of conflict.

Also, hire trustworthy, independent, and legal escrow agents who are not biased towards any of the parties.