What is an Earnest Money Deposit?

What is an Earnest Money Deposit?

If you are in the process of buying a home and working with a real estate agent and lender you’ve most likely heard the term “earnest money” mentioned. Here’s a guide on what exactly that means.

What is earnest money?

When a buyer decides to purchase a property, they make an offer, negotiate on a purchase price and execute the offer after all parties have come to terms. One of the most important ‘terms’ of the contract includes earnest money, which is also known as a “good faith” payment that the buyer is to pay within three days of executing the contract.

This initial payment is paid to a third unbiased party - the title company - and put into an escrow account for safe keeping. This monetary value gives some reassurance to the seller that the buyer plans to go through with the transaction, as well as gives the buyer some extra time to conduct a title search and get their finances in order before closing. Should the buyer make it to the closing table without terminating the contract after the option period, the earnest money deposit is applied to the buyer’s down payment and closing costs.

How much should your earnest money deposit be?

Fortunately for negotiation purposes, there are currently no set requirements for earnest money amounts - the amount will depend primarily on local real estate markets and custom. However, the amount often ranges between 1% and 2% of the sales price of the home. So, for a $250,000 house you may be paying anywhere from $2,500 to $5,000 when you execute your contract.

The amount you pay can also be determined by a few other factors - how interested others are in purchasing the property, the state of the housing market, and how quickly you can close on the home. If you are in a seller’s market, other buyers may be willing to pay a higher earnest deposit, possibly resulting in the sellers to favor such offer. In this case, your deposit could possibly range upwards of 5% of the purchase price, maybe even more. While a sales price percentage is common, some sellers, typically builders, prefer a flat amount such as $5,000 or $10,000.

If the thought of a high earnest money deposit intimidates you, it’s important to remember that it’s part of the money you’ll have to come up with soon after making an offer anyway. Think of it as a security deposit on your down payment.

Know to whom you’re giving your deposit

Never give your deposit directly to the seller. Instead, make the check out to a neutral third party such as a title company, legal firm, real estate brokerage or escrow company. You should verify that the funds will be deposited into a separately maintained trust account, and you should always obtain a receipt from your escrow agent.

Yes, you can reclaim (or lose) your earnest money

If you have the right contingencies in your contract, you may be able to reclaim your earnest money deposit, should you terminate if one of the specified issues arises. For example, if major defects (such as unsafe electrical system) turn up in the inspection report and a contingency for such an occasion is included in the contract, the earnest money would be returned.

However, it works the other way around as well. The seller keeps the money, for example, when a buyer chooses not to go through with the sale for a reason outside of what the contingencies specify, or if timelines for things such as appraisals and inspections are not honored. To prevent this, make sure the proper contingencies are included in your contract and abide by the deadlines to which you agreed.  

Note: If you are buying a foreclosed property you should be cautious with your earnest money deposit. These homes are usually sold “as is” and the money will be stipulated as nonrefundable by the seller. Be sure to perform your due diligence before making an offer so that you don’t end up losing your earnest money deposit should you decide to walk away from the contract.

Your earnest money deposit is something that a good real estate broker will guide you through. Contact a Door.com Agent today to find a trusted advisor for your home-buying journey!

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