Buying a home is a long process with a number of requirements you need to meet. One of them is the bidding wars—third-party problems with the resources or issues with the sellers. It is essential that you are aware of these things before taking the plunge into buying a property.
When you make an offer for your home, you still must show the seller that you’re serious. Earnest money is the way to prove that you want to commit and you’re serious about buying the house. In this article, we’re going to find out everything about earnest money.
What is Earnest Money?
Earnest money is a form of down payment that you make before closing on a house. It is also known as a “good faith deposit.”
Earnest money makes a buyer legit, serious, and committed to purchasing a house. These traits make a person reliable and responsible in terms of money.
Once the buyer and seller agree to a purchase agreement, the house will be off the market. The transaction will flow through the process until the closing.
However, there are times that the deal falls through. When this happens, the seller must list the home off to market again, resulting in a big financial hit.
Earnest money will enter the picture for the sake of the seller. Earnest money protects the sellers if their buyers back out.
Usually, it is about 1%-3% of the sale price and held in an escrow account until the deal finishes. On the other hand, the exact amount depends on the custom of the market.
If everything smoothly flows, the earnest money will be indicated to the buyer’s closing costs or down payment.
The buyer could get their earnest money if the deal did not happen. The agreement will be invalid if there are any contingencies in their contract or a failed home inspection.
When the buyer practices depositing earnest money, they’re more likely to not place offers in different homes.
There’s also a decrease in the possibility that the buyer will walk away after taking the home off the market.
The Importance of Paying an Earnest Money
In reality, earnest money is not a requirement in buying a house. However, it can be necessary if you’re looking for a place in a competitive real estate market.
House sellers tend to give buyers an advantage who give good faith deposits. Earnest money allows sellers to ensure that the deal won’t fail.
Both sellers and buyers have an advantage if there are good faith deposits. Earnest money will play the role of added insurance in the transaction between seller and buyer.
Good faith deposits could also decrease the amount a buyer needs to pay in closing. That’s because it’s applied directly to the closing costs or down payment.
In summary, It is money that buyers give in the earlier buying process.
How Much Earnest Money is Enough?
Generally, the amount of money a buyer should offer depends on the property’s specific real estate market.
The slow market’s languishing real estate listing may not need that much earnest money. On the other hand, it is different in a hot market wherein there are multiple buyers.
There are times that a buyer wants to buy in a neighborhood that has bidding wars and cash offers. It is a better idea to provide a higher-good faith deposit.
A real estate agent can be a buyer’s guide in knowing how much earnest money they need to offer. Since they see the process of it, it is better to work with a real estate agent.
Another thing, in competing with other people, the best idea is not to undercut the good faith deposit amount. Undercutting the earnest amount may make the buyer lose the property to other more substantial offers.
On the other hand, in a moderate or slow market, the agent can advise the buyers. They can say that earnest money in the standard range will be sufficient for the property.
Is Earnest Money Refundable?
Good faith deposits have contingencies that protect the seller and buyer in particular situations.
The sale can be finalized when the buyer and seller meet specific criteria or contingencies. Finalization will happen once the buyer’s offer on a home and the sellers accept the offer.
The criteria or contingencies are listed in the cover of the inspection and purchase agreement, mortgage, and appraisal approval. Below are the contingencies that both parties should accomplish:
Home Inspection Contingency
One of the common reasons why potential buyers back out from a deal is because of home inspection. Professionals inspect the buyer’s home, and they can see some errors in the house.
Some elements in the house are needed to have a repair that can be seen by the professional.
With that, home contingency can help the buyers back out from the deal. However, some buyers don’t want to back down from the agreement.
They can talk with the seller and repair the damages or ask them to lower the price. When they agree to reduce the cost, the buyer will do the repairs herself/himself.
It is essential to have appraisal contingency because it protects the buyer if the home is overvalued. In buying a home, the lenders hire an appraiser to know the property’s fair market value.
The third-party appraiser compares the market value of the property to the similar homes that are on sale. If the appraiser finds out that the property is appraised at less than the sale price, the buyer can decide.
With the use of appraisal contingency, the buyer can choose not to move forward with the agreement. They can get back the good faith deposit or use the appraisal to negotiate a new price.
A mortgage contingency may help people who are not preapproved for a mortgage when they put their earnest money down. It is also applicable for the people who are approved for a mortgage.
Buyers have the right to back down and get their earnest money back if mortgage contingency is in agreement. Buyers can apply for a mortgage approval to know their choices and have an idea of the affordable home for them.
A Contingency for Selling an Existing House
A contingency for selling the buyer’s existing property is included in some contracts. It is essential for the other buyers.
Sometimes, buyers can’t sell their existing home before closing the new one. This contingency helps them to walk away from the deal and have the earnest money back.
Time to Waive a Contingency
Some buyers feel pressured in waiving their contingencies, especially in hot real estate markets. In some circumstances, they may consider waiving their contingency if they are sure of qualifying for a mortgage.
On the contrary, the idea of waiving the inspection or appraisal contingencies is never a good decision. Mainly, these contingencies will protect the buyers in purchasing a home.
Steps in Protecting the Earnest Deposit
These are the few steps to be able to protect one’s earnest money:
Step 1: Open and Use an Escrow Account
The real estate market is prone to having fraud cases. Directly giving your earnest money to the real estate brokerage or seller is not a good idea.
People can avoid fraud if they go to a third party. These groups and firms hold earnest money for someone, such as escrow or title company.
The buyer can also keep a copy of the check and ask for a receipt. The funds or earnest money is held in the escrow account during the transaction until the closing.
Step 2: Determining the Contingencies
Different contingencies protect both seller and buyer. It also gives them the means to back out from the deal.
Knowing if the contract has met your side is a good idea to understand the contingencies. Both parties should pay attention to the fine print.
Everyone should understand every possible scenario that helps the buyer and seller to step down from the deal.
They should make sure that they are comfortable with the contingencies. They should also be confident about the actions that won’t make them lose their earnest money.
Step 3: Keep on Track with the Responsibilities
The purchase agreement includes the timeline of every aspect of the meet, which will protect the seller.
The timeline has the dates of the inspection or the date of mortgage approval. The seller can back out of the deal with the earnest money if the buyer misses the deadlines.
Usually, the sellers will give the buyers another time to deal with the missed deadlines. However, if the buyers still take long to handle the deadlines, it can result in a broken deal.
Step 4: Document everything
Acquiring a home is one of the most significant investments everyone can make. It’s also one of those investments that need protection.
That’s why it is vital to document everything and put it all in writing. This document will include the changes to the timeline and the buyers’ responsibilities.
The document should include the purchase agreement that shows who will get the earnest money if the deal is canceled.
For example, the contract should state the following:
- When the inspection fails, the buyer can get to keep the earnest money.
- If the buyer changed his/her decision, the seller could get the earnest money.
Everything should be clear and explained in the contract to avoid confusion.
Earnest money can be another expense or out-of-pocket cost that a buyer should have in the home-buying process. However, keep in mind that having a good faith deposit is very important.
It protects the buyer if there’s something wrong with the home. It also protects the seller if the buyer has a change of heart.
Most importantly, it proves that the buyer is serious and has a commitment to their offer.
Liked this article? You can find out more by looking at the articles below:
- Should You Use A Real Estate Agent To Sell Your Home?
- Top Questions To Ask When Buying A House: A 2021 Guide
- Single-family Home Vs. Multi-family Home: Which Is Better?
Comment below and let us know if you learned anything new from this article.