What Is Earnest Money In Real Estate and How To Protect Yourself From Losing It

what is earnest money in real estate

Whether it’s in the field of real estate or in other businesses, a seller looks for serious buyers. There are a number of ways for a buyer to prove how willing they are to make a purchase. One way for a buyer to show their commitment is through making an “earnest money” deposit.

This good-faith gesture plays a big role in the transaction between a buyer and a seller when it comes to purchasing a home. By making this payment, a seller is given the assurance that the buyer is truly ready to purchase the property. It also serves as one of the factors a seller considers when deciding whether or not to close the deal.

How Much Should the Earnest Money Deposit Be?

Typically, the earnest money deposit ranges from 1% to 5% of the property’s purchase price. Although it’s commonly between 1% and 2%, or it could also be fixed amounts. Regardless, there is no definite amount. This because the seller decides how much the deposit will be, which varies.

  • The seller receives higher offers for the property.

As a buyer, it would be better to make the smallest deposit possible in case there would be a need for you to back out of the agreement. However, sellers will most likely target the largest payment a buyer can offer since they need to be sure of a buyer’s commitment to the purchase.

Despite this, it’s still important not to offer an amount high enough to put you at risk.

  • The market is either in demand or not.

The market also determines how big or small the earnest money deposit may be.

In a market that receives less offers, you are likely to deposit a smaller amount due to the property having no other offers on the line.

If the market is hot, along with inflation of property prices is the increase in earnest money requirement. Earnest money deposits can reach up to six-figures depending on the market alone.

  • The earnest money deposit required is higher than the usual.

In markets with higher demand, there is an increase in required earnest money alongside competitors who are bidding bigger amounts. Because of this, a seller might look more into the financial status of a buyer to make sure they are able to qualify for a mortgage.

At times like this, it is also possible for a buyer to be capable of purchasing the home but failing to meet the required earnest money deposit to start the deal.

  • The buyer offered a very low amount.

The earnest money deposit is supposed to indicate to the seller how seriously a buyer wants to purchase the property, as well as show them if they are capable of purchasing it.

Although a buyer would rather pay the lowest they can, it could cause the seller to turn away from their offer especially if they have other offers to look through.

Is Earnest Money Refundable?

The earnest money deposit is usually not refundable.

It is a separate payment from the down payment for the home, which is 10% – 20% of the property’s purchase price. However, the earnest money deposit will go towards the down payment if the comes to a successful close.

Although some instances make it possible to for a buyer to reclaim the earnest money deposit. This can happen if something specified in the contract ahead of time goes wrong. Some of which are:

  • The property not getting appraised at the amount offered.

It’s possible that the property is worth less than what a buyer offers.

For example, the home is only worth $100,000 but you offer $180,000 for it.

A third-party appraiser is the one who determines the value of the home and compares it to similar properties in the market. This ensures the home is getting sold at a fair price.

  • The property failing to pass the home inspection.

The property may have major damage found during its inspection which may need immediate repairs. This is a common reason why most buyers back out of a deal.

Although a buyer can still work out with the seller to have the repairs made if they want to continue with the purchase. If they fail to come to an agreement, the buyer can simply walk away from the transaction.

  • You aren’t able to get financing.

If you don’t get approved for a mortgage after making your earnest money deposit, having a mortgage contingency will help you get a refund.

As long as the issue falls under a contingency listed in the contract, a buyer is able to get back their earnest money deposit. Likewise, if the problem that comes up is not listed on the contract, the buyer will fail to get a refund.

The deadline is an important factor to consider as well. If arranging your financing ends up taking more time than you had originally planned for, you can renegotiate with the seller to push the date further to ensure the process goes smoothly.

Earnest Money Definition

After coming into an agreement with a seller, you’ll be moving forward to other transactions and processes that go into purchasing the home such as financing, inspection, signatures and the like.

A buyer is asked to make an earnest money deposit to start off the deal. The amount is usually determined by the seller, which ranges between 1% and 5% of the agreed price. While this can be negotiated down, sticking to the given price will increase the chance of officially closing the deal.

Whether you are asked to pay for more than 5% of the home or less, the cost of the property itself won’t be increasing in numbers. If the deal comes out successfully, the earnest money deposit will go toward your down payment for the home.

Earnest Money: How Much Is Required

There is no set amount of earnest money required.

The amount required for an earnest money deposit varies on the value of the home as well as the real estate market the property is in. It is often between 1% and 5% of the purchase price or a fixed amount of $1,000 to $5,000.

This varies on the seller and other factors such as how much people are looking for properties in a certain real estate market.

Slower markets usually require smaller amounts compared to a hot market where properties get multiple buyers offering a variety of prices. If desired home belongs to a neighborhood where bidding is common, a buyer would have to make a higher earnest money deposit to compete.

If you have a real estate agent working with you, they can help you come up with a fair price you can offer for the earnest money deposit. However, competing with others on the same property is a different case. While there is an offer that seems to be most fair, you could lose the property to a stronger offer.

On the other hand, advising from an agent would help if you’re looking at a slower market. Most likely, the offer can get accepted even at the standard range.

Who Gets the Earnest Money?

While you wait for the deal to close, the earnest money is deposited into an escrow account held by a real estate brokerage, title company or legal firm.

It stays in the account until the sale is complete, which is when the money is put towards the buyer’s down payment for the property and closing costs.

By handing the money to a third party escrow agent, a buyer is able to protect themselves from questionable sellers.

For example: a buyer gives the deposit directly to the seller but later decides to back out from the transaction because of a contingency. If the seller fails to return the money, the buyer will have to pursue legal action which will end up costing them more. 

Is Earnest Money Required?

Although earnest money isn’t always a requirement, it is essential when it you’re looking for properties in a competitive market.

However, there are some sellers that require this payment before they come to an agreement with the buyer. This is one way a seller can get protection in the duration of the transaction.

Sellers tend to close deals with buyers who make earnest money deposits because it gives them the assurance that the buyer won’t suddenly decline. This is the buyer’s way of saying they are sure about the purchase they are making.

When Is Earnest Money Due?

The earnest money deposit is typically due when the seller accepts the contract or shortly after that.

Although it’s paid to a third party, it starts off the deal. For this reason, it would be best to have earnest money available before making offers on homes.

A buyer should be responsible enough to make sure they are able to meet ends with the seller throughout the whole process. While the due date is negotiable, there’s no guarantee that a seller will grant you a longer time.

Complying with the given deadlines allows the transaction to go on smoothly.

If you’re looking into making an offer soon, you should expect the earnest money deposit to be due only a day or two after the seller agrees to the contract.

When Can a Seller Keep the Earnest Money?

When an earnest money deposit is made, the seller has to wait a while before receiving it directly.

The money is held in an escrow account, usually in checks. For a seller to stay protected from a buyer clearing out the money from the account, they require their agent to cash the check.

Regardless of the whether the deposit has been cashed out beforehand or remains in check form, the money will stay in the escrow account until the deal is either closed or canceled.

If the seller indicates that the deal is off when they buyer fails to meet the deadline, they have a chance of receiving the money on the said date.

Therefore, the seller gets to keep the earnest money deposit either when the buyer fails to uphold their end of the deal or once the agreement comes to a close.

How to Show Proof of Earnest Money Deposit

The moment a buyer makes their earnest money deposit and obtains a mortgage, they will have to show proof of the earnest money deposit.

While it seems simple, some cases may cause this problem to drag on. Say, you might have deposited the earnest money before writing the check. But now you no longer have the funds available to write the earnest money deposit check.

It’s not good enough to simply make the earnest money deposit without any proper proof on paper.

When it comes to this point, as a buyer you will have to replace the earnest money deposit to present documents supporting it. Be aware that a lot of paperwork will be involved in the process.

After the money gets deposited to prove the earnest money has been paid, the amount you put goes towards the available balance.

For example, if the balance is at $4,000 and the initial deposit was $2,000 then the remaining amount to be worked with is only $2,000 more.

There should be an updated bank statement showing where the earnest money has cleared the buyer’s account.

If there is a case where the updated bank statement isn’t available, a printout is acceptable given that it shows verification that it came from the buyer’s online account. The details should also match up with the provided statement.

The said printout should also cover transactions and deposits, which should also be proven.

How to Protect Your Earnest Money

Your earnest money deposit should be protected, despite this payment being made to prove your sincerity to a seller.

There are a lot of ways to protect the deposit, such as:

  • Using an escrow account to deposit the earnest money.

Fraud is present in any business, even in the field of real estate. Because of this, it’s best not to give the deposit directly to the seller.

Consider handing the earnest money over to a third party such an escrow or title company.

The payment is usually made through wire transfer or checks. Keep receipts and copies of the payment since this will be needed some time later.

  • Know your contingencies.

The contract contains certain contingencies to protect both the seller and the buyer, as well as give them the right to back out of the deal if something occurs as listed in the contract.

It’s important to know and understand your own contingencies as much as you understand the seller’s. This will allow you to know what could impact your earnest money deposit negatively and how to prevent it from happening.

Make sure you are comfortable with the contingencies set for both you and the seller to comply with. However, as a buyer you should ensure you will not take actions that will cause you to lose the deposit.

  • Keep track of your closing responsibilities.

The agreement typically includes a timeline for the buyer to follow showing what dates should be met, such as the date for when the mortgage must be approved and when the inspection should be done.

If you miss the deadlines, the seller will have the right to back out of the deal with your deposit.

Although there are some sellers who agree to push dates further back, they may still decide to cancel the transaction if it takes up too much time.

  • Put everything in writing.

From the changes in the timeline to the buyer’s responsibilities, everything should be written down to protect the investment.

A home is a big purchase, which is why a buyer should see to it that it doesn’t go to waste.

You should make sure the contract is explained in a detailed manner. This includes who gets the earnest money deposit if the agreement is canceled under certain situations.

For example: the buyer gets to keep the earnest money if the inspection fails, or the seller gets to keep the deposit if the buyer fails to meet the deadlines.

Every detail should be laid out properly.

Dustin Heiner

Dustin Heiner is the founder of Successfully Unemployed and the host of the Successfully Unemployed Show. Dustinquit his J.O.B. by investing in real estate and has a passion to teach others to quit their J.O.B. at Master Passive Income.

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