Understanding Earnest Money

It can be difficult to set yourself apart when you are a buyer in a seller’s market. Sellers gain an advantage when housing prices rise and demand increases or remains high. Combine that with low rates, and prospective buyers begin to accumulate quickly. When such conditions exist, it becomes increasingly important for buyers to show the seller that they are worthy of their trust. One way to show a seller that you intend to purchase a home you have made an offer on is through earnest money.

According to Rebecca Lake and Lance Cothern at U.S. News, earnest money is “a ‘good faith’ deposit the homebuyer provides with an offer, to show the seller an intent to follow through on a home purchase.” The funds are then held in an escrow account until closing, usually with the seller’s real estate broker, title company, or escrow company. Upon reaching closing, the money is released from escrow and becomes available to you. Many buyers choose to apply it towards the down payment after it is made available.

One reason that earnest money is desirable to sellers is because the status of the home’s listing is changed to “under contract” after an offer has been accepted. Once this happens, most interested buyers naturally decide to look at other homes. When a buyer chooses to back out of a contract without putting down earnest money, many of those potential buyers have already moved on.

Buyers should understand that they are unlikely to recover their earnest money if they decide to back out of a contract. The earnest money gives sellers the ability to cover mortgage payments and other expenses they had not expected to accrue after the closing date. However, earnest money may be refundable under certain circumstances, including:

  • The home fails inspection
  • The seller fails to deliver on a promise in the contract
  • The home does not appraise correctly
  • Financing is delayed or denied
  • Title search issues occur

So, how much earnest money are buyers expected to put down? The general rule is 1% to 5% of the home’s purchase price. Therefore, a $300,000 home might require a deposit somewhere between $3,000 and $15,000.

According to American Family Insurance, earnest money is usually due within three days after an offer has been accepted. It is important to pay it on time, as you will want to ensure all terms of the contract are met on both sides.

As you determine whether or not to put earnest money down the next time you make an offer on a home, there are a few things to keep in mind. First, remember the contingencies you agreed to with the seller. These are meant to financially protect both parties. Second, be sure to write everything down. Verbal agreements do not hold any weight at the end of the day. If there is something you want before the contract is submitted, make sure to include the request in the contract. Finally, stick to deadlines. Keep track of what needs to be accomplished, such as scheduling a home inspection and showing up to closing with all the necessary documents and items.

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