Earnest money is a good faith deposit held in escrow ranging from as little as 1-2% up to 10% of the home’s sales price, depending on the competitiveness of the market. This is the money a homebuyer pays the seller when entering into a home sale contract, taking the home off the market while allowing the buyers a specified period of time to close.
Before entering into a home sale contract, it’s helpful to understand the earnest money deposit.
About the Earnest Money Deposit
The earnest money deposit is paid to the seller and represents the buyer’s good faith to buy their home. This helps sellers avoid wasting time with buyers who may not be fully committed to going through with the purchase.
Earnest money is not a legal requirement to purchase a home in the U.S. While you’re not legally obligated to include earnest money, it’s especially important in competitive real estate markets. When multiple buyers are making offers on the same property, an earnest money deposit is a good way to stand out as a serious buyer.
In more competitive real estate markets, sellers may require earnest money from buyers. While the typical earnest money payment is around 1% of the total buying price for the home, buyers are sometimes asked for as much as 5%. However, some sellers may ask for up to 10%, though this is rare.
Earnest money is not always calculated as a percentage. A flat rate may be requested instead, unrelated to the cost of the home. Typically, the requested payment ranges from $1,000-$5,000, but it may be much higher for properties in more competitive markets.
Holding Earnest Money in Escrow
The full earnest money amount is paid into an escrow account that is held by the seller’s broker, escrow company, legal representative, or title agent. At closing, the earnest money deposit will be used as specified in the agreement. If the sale of the home falls through, the earnest money may, or may not, be returned to the buyer, depending upon the specifics of the agreement.
Escrow is the safest way to hold the earnest money deposit. Through an escrow agreement, the deposit may be refunded to the buyer based on the terms of the agreement. However, if the payment is made directly to the seller, the buyer may have difficulty getting a refund, especially if the deposit money has been spent.
Earnest Money Contingencies
A home sale contract often contains contingencies, such as the closing date and deadlines for completing such tasks as the inspection and appraisal.
If anything should happen to make the buyer or seller withdraw from the sale, it’s helpful to have contingencies in the contract detailing how the earnest money will be handled. When conditions are not placed on the earnest money, there is a higher risk that the buyer will not be refunded the earnest money deposit if the sale falls through.
Common contingencies that warrant the refunding of the earnest money include:
- Failure to obtain financing: Even buyers who are pre-approved and have high credit scores may sometimes be denied financing.
- Low home appraisal value: If the home appraises at a lower value than the seller is asking, the buyer may choose to back out of the contract.
- Unsatisfactory inspection results: If significant structural issues are found during the inspection, the buyer may choose to withdraw from the sale.
A real estate agent can assist the homebuyer in adding contingencies to the home sale contract that could result in a refund of the earnest money payment.
Earnest Money vs. Down Payment
It’s important to note that earnest money is not synonymous with the down payment paid on a home. The home sale contract should state details on how the earnest money should be dispursed at closing. Typically, the earnest money is applied to the down payment and/or closing costs.
Marimark Realty
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To begin the journey of purchasing or selling your home, or purchasing commercial or investment properties, contact us at your earliest convenience.