Your real estate agent – or the seller's agent – will ask about "earnest money" as you get closer to making an offer on a home. Earnest money is a form of security deposit, sometimes known as a "good faith" deposit, given to a seller to prove that you're serious about buying a home. But there is a little more to it than that, as we are going to explain here.
How Earnest Money Works
The money you pay after a property seller accepts your offer on a house is known as earnest money. Earnest money assures the seller that you are acting in good faith as a homebuyer and provides them with some recompense if you back out of the deal for any reason other than a genuine, contractual cause.
When the seller's agent receives confirmation that your earnest money has been paid into an escrow account, the listing will be marked as pending sale, effectively pulling the property off the market. Various inspections, appraisals, and potentially other stipulations you included in the offer contact can now move forward in order to complete the purchase.
How Much Earnest Money Should I Offer?
Earnest money is usually between 1% and 3% of the total sale price. In a seller's market, where there are more buyers than homes for sale, sellers might expect to receive more earnest money. Make sure to discuss how much earnest money you should offer in the housing market you're in with your real estate agent before you make a formal offer.
Do You HAVE to Offer Earnest Money?
In the most technical sense, the answer is no - earnest money is not required when making an offer on a home. However, without a good faith deposit of some sort, your offer is unlikely to be seriously considered by the seller.
Who Do I Pay Earnest Money To?
Your earnest money deposit is usually sent to an escrow or title company, which keeps it in an escrow account until the transaction is completed. The deposit may be put into escrow with them if you work with a real estate attorney. Depending on the conditions of your contract, you can pay this deposit using a personal check, a bank cashier's check, a postal money order, or wired funds.
What is Earnest Money Applied Towards?
The earnest money you paid can be applied toward closing expenses or a down payment after the house has been officially closed on. The earnest money deposit is not kept by the home sellers because the sale went through.
Are There Times a Seller Can Keep a Good Faith Deposit?
Your earnest money may very well belong to the seller if you fail to meet the contractual terms of your offer. This is just one of the many reasons that it is so important that you understand your offer and the resulting contract with absolute clarity before it's submitted, even if your real estate agent is drawing it up for you.
Are There Situations In which Buyers Get Their Earnest Money Back?
You may be able to reclaim your earnest money as a buyer for a number of reasons.
First, if the seller fails to uphold their end of the purchase agreement. For example, if the seller agreed to fix defective windows after the house inspection, but did not do so by the contract deadline. A buyer can back out of a transaction and demand a return of their earnest money if there is a violation of contract.
Second, if you have a contingency in place and a justification to cancel the contract linked to that contingency. You can include a number of contingencies in the contract, and if they aren't met, you can walk away with your good faith deposit.
Other situations when your earnest money might be reimbursed include:
A lien is discovered against the property by the title firm.
Your lender refuses you the loan, but your offer includes a financing contingency.
If you have an appraisal contingency and the home appraises at a lower price, but the seller refuses to lower the price, you may be able to negotiate a lower price.
You may be able to negotiate the terms of your contract if you have a contingency. You might be able to ask the seller to make repairs or issue an escrow credit to pay the agreed-upon repair charges, for example. In most cases, a buyer and seller can reach an agreement to complete the transaction and the deal can be done, especially if your real estate agent is a great negotiator (which they should be.)
By now, you will have realized that earnest money is usually a sizable chunk of cash.
Home buyers frequently make mistakes when it comes to earnest money deposits. To avoid being one of them, read on to learn how to avoid these blunders.
Offering Too Little
Most homes receive multiple bids from eager bidders in an active seller's market. In order for a buyer's offer to stand out, they frequently need to include an EMD that will attract the seller's attention. In a strong market, $20,000 to $25,000, or 4% to 5%, is not uncommon on a $500,000 home, depending on the number of competing offers.
However, we do warn buyers that if they default on the contract, the EMD may be jeopardized, so they should be very serious about purchasing the home: The bottom line for buyers is this: Consider the possibility of losing the earnest money versus the possibility of losing the house.
If a large earnest-money deposit worries you, keep in mind that you'll have to pay the down payment 30 to 45 days after making an offer. Earnest money is simply a way for a buyer to pay a portion of the down payment in advance, so a higher EMD shouldn't be too difficult to swallow.
Removing Contract Contingencies
A common mistake buyers make with their earnest money deposit is agreeing to waive conditions that might otherwise provide them with wriggle room. Buyers, for example, will lose their earnest money if they agree to remove a loan contingency and their loan falls through.
Never give up your right to cancel a purchase until you're very certain you'll be able to complete it. Other contingencies, such as an uninsurable home, inspection issues, a troublesome title search, or a house that doesn't appraise, protect buyers by allowing them to cancel a contract without penalty.
Agreeing to Void a Contract Too Quickly
When a home transaction fails, both the buyer and the seller must sign a document voiding the contract. If a seller refuses to deliver all the earnest money to which a buyer believes he or she is legally entitled, the buyer can refuse to sign the agreement, thus rendering the home unsellable by placing a blemish on the title. To put it another way, buyers should never, ever sign this contract unless they are certain they will receive all the EMD they are entitled to.
Having Unreasonable EMD Refund Hopes
Here's a scenario that happens more often than you might realize. A couple agree to purchase a home, make an earnest money deposit but then break up a week before the closing, and hope to get their earnest money back. Or one half is transferred at work and the property they planned to purchase no longer makes sense for their new commute.
Personal issues like these may be extremely serious to you, but they aren't a good enough excuse to back out of a property purchase. Fighting for that EMD is usually a waste of effort if you're bailing on an agreement for no legal reason. You'd just have to accept the fact that it's gone and move on.
Getting ready to buy a Waterloo Region home, or sell the one you own? Let Team Pinto use our huge experience and expertise to help you. Contact the award-winning Team Pinto here, or book a free Zoom consultation to discuss your unique Waterloo Region real estate needs here.