What is Earnest Money?
Earnest money is a deposit the buyer puts down when they’re interested in buying a house. This money shows the seller that the buyer is serious about buying the home. It also protects the seller if the buyer backs out of the sale.
If you’re starting the home buying process, here is what you should know about how earnest money works.
How does an earnest money deposit work?
When a buyer is serious about buying a house, the buyer and seller will sign a purchase contract. This contract lists the terms of the sale, including the total sales price, the closing date, and a list of items that need to be completed before the purchase is complete. It also lists any contingencies that would let the buyer back out from buying the home without any penalties.
The buyer will make an earnest money offer to the seller as part of their overall offer to purchase the house. Earnest money could be a flat fee or it could be a percentage of the total sales price of the home.
In general, buyers can expect to pay between 1% and 10% of the overall sales price in earnest money. However, a real estate agent familiar with the local real estate market can give advice to buyers about what is normal for the local housing market.
After making a purchase agreement, the buyer then has time to conduct a home inspection and appraisal. Earnest money is the buyer’s good faith deposit during this period, which can take some time.
Earnest money doesn’t go directly to the seller. Instead, it’s held in an escrow trust during this period. Buyers can send a certified check or personal check to the escrow company, or make a wire transfer.
The escrow company will hold this money while the inspections and final negotiations are going on. An escrow company could be a title company, or it could be a bank or even a trusted third party like a law firm.
If the buyer decides to buy the house, earnest money is put either towards the down payment or the closing costs on the house. On the other hand, if the buyer decides not to buy the house, the money could go to either party, depending on the situation.
When does the buyer get to keep the earnest money?
In certain situations, a buyer is allowed to back out of the purchase of the home and keep the earnest money. Specifically, buyers can back out when they have an inspection contingency or a finance contingency written into the contract, and if the house is valued significantly lower than the sales price.
Buyers can protect themselves by making sure these “exits” are written into the purchase agreement and by making sure they understand the dates by which they need to raise any objections to the sale.
When buyers and sellers sign the initial contract, there is usually a clause called “inspection contingency.” This part of the contract means that if there’s something serious that turns up in the inspection, the buyer can say “no” to the house without forfeiting their deposit.
Serious problems that can turn up during an inspection include:
- Mold and water damage
- Building code violations
- Structural hazards, and
- Issues with the foundation of the house.
Sometimes, a mortgage lender won’t agree to lend the buyer the money to purchase the house unless the seller agrees to fix the home. In other situations, the buyer may decide there’s too much damage that turned up in the inspection, and they don’t want to buy the house anymore.
Sometimes, the buyers may not be able to get the financing from a mortgage company they were hoping to receive. If the buyer isn’t able to actually buy the house, they are able to have the earnest money returned to them if they have finance contingency written into the contract.
Appraised value lower than sales price
Finally, during the appraisal, it could turn out that the house is worth significantly less than the sales price. If this is the case, the buyer may not be interested in paying the full asking amount for the house.
When does the seller get to keep the earnest money?
In other situations, earnest money goes to the seller if the buyer backs out of the house.
If the buyer waives inspection and finance contingencies, and the sale falls through because of defects that turn up in the inspection or the buyer isn’t able to secure financing, the seller gets to keep the earnest money.
The escrow company can also give the earnest money to the seller if the buyer doesn’t meet deadlines in the original agreement, or if the buyer brings up defects after the dates listed in the purchase agreement.
Additionally, buyers sometimes just change their minds about purchasing a house. They may get a new job out of state, or get cold feet. If a buyer can’t point to any defects and is able to secure financing, the earnest money goes to the seller.
Buying a home can be complicated, but it’s important to make sure you understand every step in the process. Earnest money protects both the buyer and seller, and lets the parties make an informed decision when buying and selling a house. Both the buyer and seller should understand what earnest money is, how it works, and what happens to the money if the deal falls through.
If you’re interested in buying a house, the right mortgage lender can help guide you through the escrow and every step of the way in the process. Contact our Highly Motivated Vercellino team today by calling (480)-800-8387