What would the ideal real estate transaction look like? Would it consist of a homeowner and perspective buyer agreeing on a selling price, signing a purchase agreement, and then sealing the deal with a handshake and a small down payment? This would probably suffice in a perfect world where the terms “breach of contract” and “buyer’s remorse" never reared their ugly faces.
Unfortunately the world we were born into is not real estate utopia and the reality of home buying is as follows: Once you make an offer and sign the purchase contract, you need to put money down in good faith (or in earnest) to prove to the sellers you are serious. This is referred to as an earnest money deposit and is something the first time home buyer may not be aware of.
What is an Earnest Money Deposit?
The Earnest Money Deposit is a way for the buyer to demonstrate his or her intent to follow through with the agreements set forth in the purchase contract. Keep in mind that earnest money is a good faith deposit and should not be confused with a down payment, as these two monetary classifications are not the same thing.
An Earnest Money Deposit is generally paid in the form of certified or personal check and is written out to the listing real estate brokerage. The money is held in an escrow account, which is a kind of trust fund for the seller until the closing is finalized.
How Much Earnest Money Deposit is Required?
When writing an Earnest Money Check the amount vary extensively depending on the situation. Here are just a few of the many factors taken into consideration when determining how much money should be deposited in earnest.
- Interest level from others in the property
- How competitively the property is priced
- How rapidly the buyer can get from contract to closing
- How much the buyer is offering for the property in relation to the asking price
- How the purchase is being financed
- Multiple offers on the same property
Opinions vary among industry experts regarding how much of an earnest money deposit should be offered, but the general consensus is between 2-5% of the purchase contract is best. Some sellers disregard the percentage amount and ask for a flat rate of $5,000 to $10,000.
Individual states do have their own legal limits set in how much earnest money is allowed to be given.
In cases where the buyer places little to no down payment, a higher earnest money must be given as a guarantee that he/she will follow through on the mortgage. A buyer can also make the offer on the property more attractive to the seller by adding to the earnest money.
What Are The Accepted Payment Methods for the Earnest Money Deposit?
At the time an offer is made and a purchase agreement is to be submitted, the buyer will typically write an Earnest Money Check from a personal or business checking account. Certified funds (cashier's check or money order) are also acceptable methods of payment when making the Earnest Money Deposit but cash cannot be used.
In some markets the Earnest Money Deposit is broken up into two payments. One (partial) Earnest Money Check is written and submitted with the offer (typically for half the total amount) and a second Earnest Money Check is written for the remaining amount of the earnest money deposit when the offer has been accepted (typically within one week of the offer). This is rare but it does occur.
After both parties have the come to an agreement on price and terms and have signed the purchase agreement, the buyer’s agent will either mail or hand deliver the Earnest Money Check to the listing agent who is responsible for ensuring that the Earnest Money Check is deposited into the listing real estate brokerage’s escrow account.
This is the why the Earnest Money Check must be written out to the listing real estate brokerage and not an individual. The listing broker holds this money in escrow until closing at which time the buyer will receive a credit for the amount of the Earnest Money Check on the HUD statement.
States have strict laws about how the brokers deal with the different professional escrow accounts. Under no circumstances are brokers allowed to deposit any of this Earnest Money Check into their own business bank accounts. Each broker must maintain a separate account strictly for the items in escrow.
How Buyers Can Protect Themselves and Their Earnest Money Deposit
A copy of the check on the letterhead of the brokerage should be included on that receipt:
- The person’s signature who is accepting the delivery of the check
- Specification of location and date of the check accepted
Any buyers looking to close quickly on the property should use a certified check for the earnest money.
Do I Earn Interest on My Earnest Money Deposit?
It’s important for people to understand that earnest money which has been deposited into a bank account is considered an investment. Because it’s in an escrow account, the earnest money can earn interest. If the sum totals more than $5,000, buyers will need to complete the IRS Form W-9 to get their interest on that deposit returned to them.
If The Deal Falls Apart, Is There an Earnest Money Refund?
There are cases where the process of buying a home just falls apart. For instance, buyers cannot secure the down payment necessary or fail to qualify for a mortgage loan to purchase the home even after being pre-approved. Usually when a purchase agreement has been signed by both parties, the seller removes his/her property from the market. And, when buyer defaults, the seller has lost both time and money.
It’s important to understand that a purchase agreement, for the most part, is a document with which the main purpose is to protect the buyer. This legal contract is packed with conditions and contingencies, each of which offer the buyer an opportunity to terminate the agreement and receive and Earnest Money Refund. The following are a few of the possible reasons a buyer would be justified terminating the contract and receiving and Earnest Money Refund:
- The buyer is unable to obtain financing
- Lender’s appraisal value is less than the purchase price
- Seller fails to maintain the condition of the property
- Building or use limitations which interfere with buyers intended us e of property
- The discovery of a requirement for flood insurance on the property
- Major structural or safety defects discovered during the inspection process
- Misrepresentation of the property on the Residential Sellers Disclosure
- Clouds on the property’s title
- Planned municipal improvements which would negatively affect the property value
- Refusal to accept mandatory provisions of a Homeowners/Condominium Association
These are all instances where a buyer would (in most markets) be entitled to an Earnest Money Refund.
Often times a buyer simply gets “cold feet” and has a change of heart about purchasing a property. This is not sufficient cause to terminate a purchase agreement and in that situation there would be no Earnest Money Refund.
However, if the buyer and the seller can come to a mutual agreement on their own regarding the Earnest Money Deposit, it could possibly be split 50/50. Keep in mind; all states have different laws regarding Earnest Money Refunds and the contingencies above are only reflective of the Fort Wayne real estate market. Contact a local REALTOR to learn more what the exact regulations are in your area.
Should something go wrong early in the home buying process, the seller will generally give up the claim to the Earnest Money Deposit, ensuring it goes back to the buyer minus a small cancellation fee stipulated by the brokerage.
Should a more serious issue arise – such as who is at fault for deal falling apart – the REALTORS® will deal with the issue to resolve it in a fair manner.
If nothing has worked, and the parties have come to an impasse, it is best for buyers to forfeit an Earnest Money Refund and allow the sellers to keep the money for lost time on the market. Still, this kind of scenario is rare.
The Most Important aspect of the Earnest Money Deposit
Most folks are mistakenly under the impression that the earnest money is an additional cost to home buying and this isn’t true. The earnest money is actually credited at closing towards the buyer’s down payment. If the earnest money deposit is larger than the required mortgage down payment, the buyers will receive the balance at closing.
In summary, the earnest money deposit is a way to show the seller you are serious about purchasing their property. The more money you give in earnest, to better your offer looks. If you are financing your purchase with an FHA loan which requires a 3.5% down payment, why not just deposit 3.5% in earnest when making your offer to show the seller how serious you are about the purchase?
All of this money will be applied to the down payment you are required to make on your mortgage at the closing table if the offer is accepted. If the offer is rejected, the check will come back to you and never even be deposit. This would be a very easy way to beat out any other similar offers that might come in on said property at the time you submit yours.
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For more information about the Earnest Money Deposit, or for answers to any other real estate related questions you might have call me, Jason Patton, today at (260) 450-1812, email me, or send me a message via the contact form at the top of the page.