Earnest Money: What You Must Know Before You Pay
Earnest Money is something that comes up just about all the time when buying a home. Homebuyers love the process of searching for the perfect house for their family.
During this process, they encounter different terms and phrases. One of these is earnest money.
What is Earnest Money in Real Estate?
Earnest money in real estate is basically good faith deposit for the purchase of the property.
Although it doesn’t need to be in monetary form, most of the time, it is. Technically, earnest money can also be any other item of significant value. Earnest money is the money that the buyer includes upfront with the initial offer.
This shows your commitment to purchasing the house and your financial capacity to do so.
This is your way of saying that you are seriously committed to entering into the contract and your money is the proof.
How Much Should the Earnest Money Deposit Be?
The amount of earnest money often depends on the property’s purchase price.
However, it can also differ according to the custom and locality. Most of the time, the amount of earnest money deposit is negotiable. This amount is not legally or contractually definite or fixed.
In practice though, it is whatever the seller requests from the buyer and what the buyer agrees to.
For practical purposes, deposits can range from 1% to 3% of the overall purchase price although this percentage can go higher in markets with good sales.
The seller is not obliged to accept this initial amount that the potential buyer will offer.
There might be a need for sellers to increase the earnest money for several reasons.
- The buyer requests for a longer period until closing
- The buyer offers a very low or zero down payment
- The seller receives other offers for the property
- The buyer offered a very small amount in general
- The increase in earnest money can be required if the seller is worried about the ability of the buyer to qualify for a mortgage
Is Earnest Money Refundable?
Earnest Money is usually considered non-refundable. But there is an exception.
The option period.
This is the period of time where the buyer can inspect the property AND cancel the contract without losing their earnest money. Items that a buyer would need to inspect on the property are, but not limited to:
- Home inspection
- Roof inspection
- Foundation inspection
- Pest inspection
- Electrical inspection
- Any other inspection the buyer deems necessary to continue with the purchase of the property.
In this period, it does not solely depend on inspections for the buyer to back out. It can be any reason, stated or not, for the buyer to back out of the contract.
If the buyer decides to cancel the sales contract at one point in the option period, the buyer will receive a refund of the earnest money.
If the buyer decides to cancel the contract when the option period already ended, the earnest money deposit will be considered as non-refundable.
Earnest Money Definition
Earnest money is the deposit that the buyer gives to the seller to show good faith.
Earnest money is often held in a trust account or escrow until closing when the funds can be used for the home’s purchase price. Earnest money shouldn’t be confused with closing costs or down payment.
This deposit will show how serious the buyer is in purchasing the house and that they will follow the purchase agreement.
The initial home offer also specifies terms and amount of earnest money deposit.
This earnest money is going to be non-refundable after the set time-frame known as option period.
The except when there are some conditions wherein the buyer can get the deposit back such as the option period
Earnest Money How Much is Required?
The required earnest money deposit varies according to the market.
No set or definite amount is implemented but most of the time, this is equivalent to 1 to 3 percent of the home’s purchase price.
However, there are some instances when an amount of $1,000 as escrow deposit is enough, which will still depend on the seller.
A buyer must always try to settle for the least monetary amount possible in case he or she decides to drop out of the contract.
This means that sellers will always try to get the highest amount of earnest money.
In a buyer’s market with slow home sales, you can put just a smaller amount of deposit on the property.
There is a chance that you offer is the only existing one.
On the other hand, in a seller’s market where it is common to have multiple bids, it is likely that the seller will require a higher amount of deposit.
It is a must to work with a professional and expert real estate agent since they will serve as your guide during the buying process, including the enough amount of earnest money.
Who Gets the Earnest Money?
The earnest money deposit should never be, in any circumstance, given to an individual.
Avoid giving a check to a seller or even the real estate agent you are working with. There are some fraudulent cases where persons identify themselves as sellers or agents and lure prospect home-buyers to give the earnest money deposit to them, only to disappear into thin air.
The money should only be given to a third party like a law firm, escrow or title company, or a reliable real estate brokerage.
See to it that you make and keep a copy of the issued check for record purposes and always ask for a receipt.
Is Earnest Money Required?
Earnest money is not really a requirement all the time but it might be necessary if you will buy a house within a competitive market.
There is a tendency for sellers to favor good faith deposits since they want to make sure that the sale is not going to fall through.
This deposit acts as an extra insurance for the two parties involved in this transaction.
The earnest money deposit can also be lower than the required amount during the closing since this will be directly applied to the closing costs or down payment.
Basically, you will shell out some cash much earlier in the buying process.
When is Earnest Money Due?
The check for the earnest money must be handed over to the escrow in a matter of one to two days after the seller accepts your offer.
This is why it is recommended that you have available liquid funds the moment you make your offer.
The last thing you want is to submit your offer only to find out that you are still waiting for your stocks to sell or your relative hasn’t given you the promised monetary gift yet.
When Can a Seller Keep the Earnest Money?
If the buyers did not go through with the contract because they change their mind or they got cold feet, it is when they stand losing their earnest money in the deal.
Time is of the essence provision is a lesser known contingency, which sets consequences in the event that any parties in the transaction fail to meet the deadlines laid out in your contract.
It may benefit you as the seller once you arrange for the closing date and stipulate that if buyers fail to close on time, the contract is void.
With this, you will be able to keep the earnest money.
If buyers fail to uphold their bargain’s end, the earnest money deposit will be your consolation prize.
If you are serious about selling your house, you will do everything you can to avoid it from happening.
Besides, it means putting your home back in the market and starting over.
How to Show Proof of Earnest Money Deposit
In terms of documenting the earnest money deposit, it is a bit unclear as to what should be provided and the reason behind it.
Once you write an earnest money deposit and you’re obtaining a mortgage, you should prove the source of earnest money deposit.
It might seem simple.
But, what if you have deposited money just before you write the earnest money deposit check and without the cash you wouldn’t have had the funds to write check?
If the money can’t be proven with proper paper trail, the earnest money deposit isn’t good.
This time, you should replace the earnest money deposit with the documented funds.
It may cause quite paperwork mess and must be avoided along with getting cash from anybody aside from an immediate family member.
Cash from an immediate family member is a gift and with the gift letter and good paper trail is acceptable for use in the mortgage transaction.
It is important to note that the amount of non-proven money you deposit will be deducted from the available balance.
So, if the bank statement balance is $6,000 and you have deposited $3,000, you have only $3,000 to work with for purchasing your house.
Provide the Bank With Proof of Earnest Money
If you have a documented earnest money deposit and cleared your account, you’ll have to provide a bank statement that is updated. It should show where the earnest money deposit has cleared your account.
In this statement, the underwriter will be searching for updated statement balance after the cash cleared to ensure that you show enough funds for closing the transaction.
More often than not, updated bank statement isn’t available, so account activity printouts are acceptable.
The printout is only acceptable if the web address in the footer or header of the printout to show that it came from your account online.
You full name, partial account number or account number should match up the actual statement you’ve provided.
The printout should cover the activity period from the last actual statement’s closing date you have provided through current. There should be no gap in the asset activity.
Keep in mind that any new deposit that appears on the bank printout should be proven also.
How to Protect Your Earnest Money
There are some steps you should take for protecting your earnest money and these include the following:
Consider Using an Escrow Account for Your Earnest Money
The market of real estate is not immune to fraud. As results, you must not give your earnest money to the real estate brokerage or seller directly. Instead, consider going with the 3rd party like an escrow or title company that would hold your earnest money.
You will typically pay through wire transfer, certified check or personal check. Your check must be made out to the 3rd party and you may keep a check’s copy and if possible, request a receipt. The funds are held in the escrow account until the closing.
Be Aware of Your Contingencies
The contingencies protect both the buyer and seller and give every party the means to back out the deal.
To make sure that you meet your contract’s side, ensure that you understand the contingencies and you must pay attention to the fine print.
You must also understand the scenarios where you and sellers could back out and what impact could have on earnest money.
See to it that you are comfortable with the contingencies. You should also be confident with any actions you take will not result in losing good faith deposit.
Keep on Track with the Closing Responsibilities
Typically, the purchase agreement includes a timeline for when each aspect of the closing should be met to protect the seller.
It includes the date when the mortgage must be approved and by which you require an inspection done.
Once you miss out such deadlines, there might be grounds for the seller to backing out the deal with earnest money in hand.
Majority of sellers will not rescind the deal the time you miss a deadline. However, if it takes too long, it can be a deal breaker.
Put Everything in Writing Especially Earnest Money
A house is one of the biggest investments that a person will make. It is crucial to protect your investments. Especially when you are learning how to invest in real estate.
That is the reason why you must put everything in writing. It includes the changes in the timeline as well as the buyer responsibilities.
See to it that the purchase agreement will lay out who gets the earnest money once the contract is cancelled.
For example, if an inspection fails and the buyer would keep the earnest money, you must include that in the contract.
If the seller keeps the earnest money and the buyer change his or her mind, lay it out properly.
Everything must be explained in the contract in a detailed manner.
The Bottom Line About Earnest Money
Earnest money is like another extra cost you need to cover. However, it is very important.
The reason behind it is that if something’s wrong with the property.
It also protects the seller if you like out the deal and this proves to the seller that you are serious about your offer.
Get the FREE Real Estate Investing Guide
Free Investor Training
Get What You Need To Successfully Invest in Real Estate
Get All of the MPI Courses Plus Coaching!
6 Masterclass Courses
Premium online courses for any level of investor: beginner-advanced. Completely go at your own pace and can be taken through “Self-Study” or through “Membership”.
Fast-track your investing success with access all past students’ work. Get access to the list of places to invest, business contacts, lenders, and resources other students have already found.
Work with MPI Coaches and Students inside the MPI Student Community.
Student Success Program
Pair up with another like-minded student for accountability, and crush your investing goals together.
Real Estate Wealth Builders
Get the coaching, education, community, and resources you need to become a successful real estate investor.