What is Earnest Money?
It’s an exciting day when a seller accepts your offer.
It’s exciting for the seller too, but it may also feel risky.
By accepting your offer the seller will need to take their home off the market. During that time the seller is missing out on other potential buyers. If 30 days into a sale you decide to back out, the seller now has to put their home back on the market and risks missing out on getting top dollar on their home. In addition, they have to make another mortgage payment and pay more taxes and interest.
It gives sellers peace of mind knowing that a buyer is committed to making the sale go through.
One way a buyer shows commitment is by providing an earnest money deposit.
WHAT IS EARNEST MONEY?
Earnest money is a specified amount of money that you pledge to pay if you back out of the contract.
The amount of money you should put toward your earnest money depends mostly on how competitive the situation is. In multiple offer situations, sometimes people put as much as 3% for earnest money. In less competitive situations, earnest money deposits can be as low as $1,000. The most common amount we see is around 1% of the purchase price, which can either be a rounded or exact amount.
Don’t worry, as long as the home closes, the earnest money gets put toward your down payment and closing costs. The reason a buyer loses their earnest money is by backing out of the transaction for a reason other than one of the contingencies specified in the contract.
WHEN CAN YOU BACK OUT AND GET YOUR MONEY BACK?
Contingencies are items in the sales contract that will protect you if the deal falls apart for reasons that aren’t your fault. Essentially this means that you get your earnest money back. The most common contingencies are listed below.
HOME INSPECTION CONTINGENCY
There is typically a 10-business-day inspection period that allows the buyer to have the home and property inspected. If something comes up that is a deal-breaker, you can back out of the transaction within the ten-day window and get your earnest money back.
FINANCING CONTINGENCY
The financing contingency makes sure that the buyer is able to qualify for the loan they apply for. If something happens and the buyer is unable to qualify for financing, they can back out and get their earnest money returned.
APPRAISAL CONTINGENCY
The appraisal contingency makes sure the property is worth at least what you offered for it. If the property appraises for less, you can either renegotiate the contract or back out and get your earnest money back.
SALE OF HOME CONTINGENCY
If you are selling another property, typically there will be a contingency saying that your property must close first before you can close on this home.
FOR ANY OTHER REASON...YOU WILL MOST LIKELY HAVE TO PAY
If you decide to back out of the transaction after the inspection period for a reason other than the ones listed above, your earnest money will most likely be given to the seller.
As long as you are serious about buying a house, there is a fairly low risk of having a higher earnest money deposit. It is a simple way to show a seller you are serious and it gives them confidence that your offer is a good choice.
WHERE DOES EARNEST MONEY GO WHILE YOU WAIT?
Three days after your offer is accepted you will need to deposit the earnest money into escrow. Escrow is a neutral third party that holds the earnest money (and other payments like taxes) in an account.
This money will either stay in escrow until the deal closes, be returned to you if you back out due to a contingency, or given to the seller if you break the contract for a reason outside of a contingency.
Thankfully, as we mentioned before, this money can go towards your down payment at the end of a successful closing!
If you have any more questions about earnest money or any other aspects of buying or selling, you can contact us. We would love to answer your questions!