We've been working with many buyers lately and the subject of Earnest Money keeps coming up and I find myself often describing what it is and how it works. So I thought I would take a minute to share this information, as you too might want a better understanding of earnest money in a real estate transaction.
What is earnest money?
According to the dictionary, earnest money is: money paid to confirm a contract. Essentially in a real estate purchase, earnest money is a deposit that is presented with an offer to purchase a home. It tells the seller that you are committed to the purchase, and it helps fund your down payment. If you reach mutual agreement to purchase the home, your earnest money will be deposited in escrow and ultimately be used as part of the money to make the full purchase of the home.
How much should I expect to put down in earnest money?
The standard earnest money deposit is 3% of the purchase price. However, in a competitive market, putting down a larger sum of earnest money can sometimes help you beat out competition as this speaks to how serious you are as a buyer. There are no regulations on how much earnest money you should put down, but as a general rule the seller will be expecting about 3% of the purchase price of the home.
When do you make the earnest money deposit and who holds it?
In most cases, after your offer is accepted by the seller, you will deposit the promised earnest money to the Escrow Company. They will hold the funds and apply your earnest money deposit at closing towards your down payment and closing costs. In some cases and depending on the type of financing you are using, any unused portion of the deposit will be refunded to you after close of escrow.
Can you get your earnest money back?
This really depends on how your contract has been written. For example if you have an inspection contingency in your contract, your earnest money is fully refundable if you terminate your purchase due to inspection issues. If you are using conventional financing and you have included a financing contingency but for some reason your financing fails, you will be fully protected by the financing contingency and your earnest money will be fully refunded. But, if you have waived these contingencies, and you simply walk away from the purchase due to cold feet, change of heart etc., you will lose your earnest money altogether. So it is imperative that you have a complete understanding of the contingencies in your contract, how they work and the timelines allotted to each contingency.
Earnest Money Strategies:
There are many earnest money strategies and some of them can be quite scary. For instance, in a highly competitive market many buyers are doing all of their due diligence before they present an offer so that they can eliminate all contingencies. This puts their offer in a much more desirable position to the seller. In doing so many buyers are also releasing their earnest money to the seller upon mutual acceptance. This shows the highest level of commitment to the purchase and that the buyer will absolutely not walk away from the purchase. Plus the seller gets the earnest money deposit shortly after the contract is fully signed and doesn't have to wait for the home to close to get paid on a portion of the sale. This seems crazy, but it is what many buyers are doing to compete in this highly competitive market we are in.
Other strategies would revolve around the earnest money amount. Although 3% is pretty standard, sometimes it makes sense to offer more. If you are writing an extremely low offer, it may make sense to offset that with a higher than normal earnest money deposit. Likewise, if you're offer is extremely generous, you may want to pull back on earnest money a bit. These are not hard and fast rules, but sometimes these are good considerations.
I hope you find this helpful, and if you have further questions please don't hesitate to email me.