Earnest money is a deposit that a buyer makes to a seller to show that the buyer is serious about buying a home. It’s a form of security.
Table of contents
- What’s earnest money?
- How much you need
- Protecting your earnest money deposit
- Is it refundable?
What’s earnest money?
When you’re in the process of buying a home, one of the initial steps is to make an earnest money deposit, which is also known as good faith money or an escrow deposit.
The deposit is made when the sales contract or purchase agreement is signed. Sometimes, it can also be made with the offer.
The purpose is to signal to the seller that you’re serious about buying the home. It gives the seller peace of mind, and you’re proving that you’re ready to move forward in the home-buying process.
It doesn’t mean you have to buy the home because issues can arise during the inspection. It allows the seller to take the house off of the market while it’s inspected and appraised.
Although you’re making the deposit, it’s important to not get it confused with the down payment because they’re different.
Earnest money is a signal for the seller, while a down payment is a signal to the lender. A down payment is what you pay the seller when you close your home loan. It shows the lender that you can afford the home and reduces the risk.
How much you need
There’s not a set requirement for the amount that you need for earnest money. In general, you can expect to see it between 1 and 5 percent of the sale price. It’ll also depend on the community and state of the housing market.
However, you can try to negotiate the amount of earnest money that’s required. If it’s a seller’s market, negotiation might not work because buyers will fight over the house, but it’s worth a shot.
Your earnest money deposit will normally be held in an escrow account until the deal is finalized.
Protecting your earnest money deposit
The last thing you’d want is to lose your earnest money deposit. That’s why it’s important to understand how you can protect it.
The following are ways to protect your earnest money deposit:
- Make the deposit to a reputable escrow or title company, real estate brokerage, or legal firm.
- Never give the earnest money deposit directly to the seller.
- Make sure you have a contract that explains everything in detail.
- Understand your contingencies because it’ll protect you and allow you to back out of the deal.
Do your due diligence and work with a reputable professional to make the home-buying process smooth and easy.
Is it refundable?
An earnest money deposit is refundable only when your offer contract includes the contingencies that give you the means to back out. If you break the agreement or aren’t careful with reading the contingencies, the seller may be able to keep the deposit.
For example, you can set an appraisal contingency, which means you can choose not to move forward if the appraised value is less than the seller’s sale price. This ensures that you’re not overpaying for the home.
Another type of contingency can be getting approved for the mortgage. If you haven’t been approved yet, include this in your contract. It can ensure that you get your earnest money back if you aren’t able to get approved for a mortgage.
If everything goes well, the earnest money funds will typically go towards your loan’s closing costs or the down payment to the seller. If there’s money left over after that, you’ll get the extra amount back.
An earnest money deposit represents a buyer’s good faith to move forward with purchasing a home. It’s important to work with qualified professionals to help you with contracts in case the purchase falls through. If everything goes well, it’ll likely cover the closing costs.
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