Earnest money is a crucial step in the home buying process and can amount to several thousands of dollars. Earnest money deposits show the seller you're serious about buying their house and secures your offer while things like inspections, appraisal and financing get underway. The below is a guide that will explain what earnest money is, how much you might need, and what to know about getting it back.
What is Earnest Money?
Earnest money, also called a good faith deposit, is an up front sum of money you put down towards the purchase of a home when your offer is accepted by the seller. It acts as a deposit on the property and demonstrates your commitment to buying. The deposit is usually expected no more than three days after the offer is accepted. The money is typically held in a neutral escrow account by a title company until closing. An earnest money deposit is not technically required, but it is a common practice and considered essential in a competitive market. Sellers will strongly favor an offer that includes earnest money. Assuming the deal goes smoothly, that deposit is then applied to the down payment or closing costs.
How Much Earnest Money Should I Offer?
The amount of earnest money you offer can vary depending on several factors, including:
- Market conditions: In a competitive seller's market, a higher earnest money deposit can make your offer more attractive.
- Purchase price of the home: The amount is typically a percentage of the sale price (typically 1% - 3%) and often 3% in our market.
Here are some things to consider when deciding how much earnest money to offer:
- Balance between seriousness and risk: A higher amount shows the seller you're serious, but you also don't want to risk losing a large sum if the deal falls through.
- Strength of your offer: If your offer is below asking price, a higher earnest money deposit could potentially help strengthen your position.
Getting Your Earnest Money Back
The terms of receiving your earnest money back are outlined in the purchase agreement you sign with the seller.
- Financing contingencies: Most contracts allow you to back out of the deal if you cannot secure financing within a set timeframe.
- Inspection contingencies: You may be able to walk away and get your earnest money back if the inspection reveals major problems with the property. The specific terms will be spelled out in the contract. That being said, it is now a common practice for sellers to proactively get inspections done before a house goes on the market to help reduce the likelihood of a deal falling through.
- Appraisal contingencies: Earnest money may be refunded if the house doesn’t appraise for more than the purchase price, thus affecting the ability to secure a mortgage if needed.
- Breach of contract: If you back out of the deal without a valid reason outlined in the contingencies, you may lose your earnest money. The seller can keep the money to compensate for taking the house off the market and potentially having to start the selling process over.
Here are some tips for protecting your earnest money:
- Work with a real estate agent: An experienced agent can advise you on an appropriate amount.
- Read the purchase agreement carefully: Make sure you understand the terms for getting your earnest money back, especially regarding contingencies.
- Don't waive contingencies without careful consideration: While waiving contingencies can make your offer more attractive, it can also put you at greater financial risk. If you include contingencies in your offer, you’ll get the earnest money back if a contingency isn’t met.
By understanding earnest money and how it works, you can be a more confident and prepared home buyer. Please reach out to us if you have questions around this topic.
