So you have been working with your REALTOR for a while to find the perfect home in a seller’s market and you’ve finally found it! Your agent will craft the (hopefully) perfect offer to the seller with terms favorable to both parties. One of the terms of the contract is the Earnest Money Deposit, but what is it? How much is it?
Earnest money is a “Good Faith Deposit”. When a buyer and seller enter into a sales contract, the seller is taking their home off the market during the contract period. The earnest money is to protect the seller.
When you, the buyer, makes an offer to a seller on their listing, the earnest money deposit you’re offering is telling the seller that you are serious about purchasing the property in good faith, or as I like to call it, “SKIN IN THE GAME!”
The amount you decide to offer is a negotiable item in the contract, but I recommend offering at least 1% of the contracted sales price. This deposit is made payable by check, money order, cashiers check, wire or other electronic means to the title company and to be held in escrow. Time is of the essence for this deposit!
At the end of the transaction at closing, your earnest money deposit will be credited towards your closing costs. What that looks like:
- You offer a seller $200,000, with a 1% earnest money deposit = $2,000
- You are using FHA financing requiring a down payment of 3.5% = $7,000
- Estimated closing costs of 3% (this is for your loan) = $6,000
- At closing, your CASH TO CLOSE is $13,000 – $2,000 earnest money = $11,000
While this is meant to show the seller you are serious and to protect the seller, don’t worry. There are many areas in the sales contract, amendments and addendums to the contract to protect YOU and your earnest money. Having good representation on your side to make sure you are compliant with the contract and do not end up in default will assure you do not end up in a bind resulting in the loss of your earnest money deposit.
What happens to your earnest money should you terminate the contract? That depends on the circumstances. If you just decide that you no longer want to purchase the home and have no contractual out to do so, the seller can retain your earnest money. Simply getting “cold feet” or changing your mind does not protect your earnest money. When the contract is terminated, both buyer and seller will sign a release agreement stating who retains the money.
What if you and the seller cannot agree on who gets the earnest money? Both parties will consult their respective agent and hopefully agree on who the money should be released to, but should you not be able to, the title company will hold the funds in an escrow account for up to two years until the dispute is either resolved between the two parties or by a court of law. Nor your agent or the title company are mediators between the parties. If I were representing you and this situation occurred, I would advise you to consult an attorney.
Earnest money is not to be confused with Option Fee, or Termination Option . We will go into this next week!