Earnest money is a deposit made to a seller that represents a buyer's good faith to make a purchase such as the acquisition of a new home. The money gives the buyer extra time to get financing and conduct the title search, property appraisal, and inspections before closing. In many ways, earnest money can be considered a deposit on a home, an escrow deposit, or good faith money.
In most cases, earnest money is delivered when the sales contract or purchase agreement is signed, but it can also be attached to the offer. Once deposited, the funds are typically held in an escrow account until closing, at which time the deposit is applied to the buyer's down payment and closing costs.
When a buyer decides to purchase a home from a seller, both parties enter into a contract. The contract doesn't obligate the buyer to purchase the home, becausereports from thehome appraisaland inspection may later reveal problems with the house. The contract does, however, ensure the seller takes the house off the market while it's inspected and appraised. To prove the buyer's offer to purchase the property is made in good faith, the buyer makes an earnest money deposit (EMD).
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The buyer might be able to reclaim the earnest money deposit if something that was specified ahead of time in the contract goes wrong. For instance, the earnest money would be returned if the house doesn't appraise for the sales price or the inspection reveals a serious defect—provided these contingencies are listed in the contract.
In general, earnest money is returned to the buyer if the seller terminates the deal but is awarded to the seller if the buyer unreasonably terminates the deal.
While the buyer and seller can negotiate the earnest money deposit, it often ranges between 1% and 2% of the home's purchase price, depending on the market. In hot housing markets, the earnest money deposit might range between 5% and 10% of a property's sale price.
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While the earnest money deposit is often a percentage of the sales price, some sellers prefer a fixed amount, such as $5, 000 or $10, 000. Of course, the higher the earnest money amount, the more serious the seller is likely to consider the buyer. Therefore, a buyer should offer a high enough earnest deposit to be accepted, but not one so high as to put extra money at risk.
A seller may also require ongoing, periodic earnest deposits to have a prospective buyer continue to show good faith during their due diligence process. For example, a seller may require a buyer to make monthly earnest deposits on a fixed schedule over a three month due diligence period. Should the buyer fail to meet any earnest money deposit requirements, the seller may be entitled to bring the property back to market and potentially recover losses via keeping portions of the earnest money.
Earnest money is usually paid by certified check, personal check, or a wire transfer into a trust or escrow account that is held by a real estate brokerage, legal firm, or title company. The funds are held in the account until closing, when they are applied toward the buyer's down payment and closing costs.
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It's important to note that escrow accounts, like any other bank account, can earn interest. If the earnest funds in the escrow account earn interest of more than $600, the buyer must fill out taxform W-9with the IRS to receive the interest.
Different jurisdictions may have different legal circumstances around earnest money. For example, Washington state legislature stipulates slightly different definitions than Minnesota statutes.
Earnest money isn't always refundable. The good news for buyers is in most situations, as long as a buyer acts in good faith, earnest money is refundable. As long as any contract agreements are not broken or decision deadlines are met, buyers usually get their earnest money back. Specific conditions where buyers often get their earnest money back include:
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Every situation is different, but broadly speaking, the seller gets to keep the earnest money if the buyer decides not to go through with the home purchase for reasons not specified as part of the contract. For example, if a buyer simply has a change of heart decides not to buy the property, the seller is most likely entitled to retain earnest money proceeds.
Suppose Tom wants to buy a home worth $100, 000 from Joy. To facilitate the transaction, the broker arranges to deposit $10, 000 as a deposit in an escrow account. The terms of the subsequent agreement signed by both parties state that Joy, who is currently living in the home, will move out of it within the next six months.
However, Joy is unable to find another place of residence by moving day. As a result, Tom cancels the transaction and gets his deposit money back. The deposit money has earned interest of $500 from the escrow account during this time period. Since the amount is less than $600, Tom is not required to fill out an IRS form to retrieve the amount.
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In real estate, earnest money is effectively a deposit to buy a home. Usually, it ranges between 1-10% of the home’s sale price. While earnest money doesn’t obligate a buyer to purchase a home, it does require the seller to take the property off of the market during the appraisal process. Earnest money is deposited to represent good faith in purchasing the home.
Earnest money gets returned if something goes awry during the appraisal that was predetermined in the contract. This could include an appraisal price that is lower than the sale price, or if there is a significant flaw with the house. Importantly, though, earnest money may not be returned if the flaw was not predetermined in the contract or if the buyer decides not to purchase the house during an agreed-upon time period.
To protect an earnest money deposit, prospective buyers can follow a number of precautionary steps. First, buyers can ensure that contingencies apply to defects, financing, and inspections. This protects the deposit from being forfeited in the case that a major flaw is discovered, or that financing is not secured. Second, carefully read and follow the terms of the contract. In some cases, the contract will indicate a certain date by which the inspection must be made. To prevent forfeiture, the buyer should abide by these terms accordingly. Finally, ensure the deposit is handled adequately, which means that the buyer should work with a reputable broker, title firm, escrow company, or legal firm.
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As long as a buyer follows the terms of the contract and adheres to all deadlines agreed to with the seller, a buyer will most often receive their full earnest money deposit(s) back. Should the buyer fail to comply with the agreement, the seller may be entitled to receive some or all earnest deposit funds.
In an agreement between a buyer and seller, there are often a number of contingencies outlined that spell out the terms where a buyer may back out of an agreement. These contingencies include failure of a home inspection, failure to secure financing, or failure to sell a separate existing property.
If the buyer decides to not proceed with the sale for reasons outside of these agreed to contingencies, the buyer is at risk of losing earnest money.
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When a buyer and seller enter into an initial agreement to transfer ownership right of property, the buyer is often required to make a deposit of earnest money into an escrow account. There's a number of reasons the buyer and seller can agree to where the buyer can back out of the agreement. However, should the buyer break contract or not meet required deadlines, the seller may be entitled to keep the earnest money as compensation for the break of good faith.
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