Earnest Money: What Is It and How Much to Pay?

In August 2023, almost 60,000 home-purchase agreements were canceled due to a lack of assurance from the buyer’s side. In the current competitive housing market, earnest money is a way to show a significant level of commitment to the seller.

Since sellers prefer serious buyers, include earnest money with your home offer to turn the scales in your favor. This guaranteed deposit can help you secure your dream house.

You hand over this money to the seller or escrow when you sign the agreement to buy the house. The contract explains the rules for the allocation of funds and reimbursement. 

What Is Earnest Money?

Earnest money is deposited before the house closing, serving as a demonstration of serious intent to purchase. This upfront payment, also referred to as a good faith deposit, is a common practice in real estate transactions.

The exact deposit amount depends on your local market rate. Both you and the sellers can use it to pay off the amount either as the down payment or the closing costs.

The money gives you the ability to negotiate with the seller to conduct the home title search, property appraisal, and inspections before closing. In case of a failed home inspection, the deal might not work and you get your money back if the seller breaks any contingencies outlined in the purchase agreement.

How Much Earnest Money Do You Need to Pay?

Earnest money is usually between 1% to 2% of the home purchase price. However, this cost can generally go as high as 3%. This depends on factors like the home price and local market trends.

That means, for a $300,000 house, the payment amount ranges from $3,000 to $9,000. Higher earnest money strengthens your negotiating position and signals a greater commitment to the seller.

How Does Earnest Money Work?

Once the seller agrees to your offer, you must sign a purchase agreement. This legal contract outlines the entire process of how you will give the earnest amount to the seller.

Once the contract is signed, deposit the earnest money into an escrow account. This account is managed by a third party like a legal firm, real estate agent, or title company. You must do this within a day or two after the seller accepts the offer.

If you want to get your earnest money back, its feasibility hinges on the conditions stated in the contract. In the absence of provisions addressing refunds, sellers can retain the money. Therefore, you should thoroughly examine contractual terms.

Is It Refundable?

Here are situations where you may receive a refund:

• The seller fails to provide a clear title.
• The seller refuses to address inspection issues.
• The appraisal price is lower than agreed.

The possibility of getting your earnest amount back depends on the purchase contract clauses.

What Is the Importance of Earnest Money?

Earnest money gives buyers time to assess finances and conduct thorough inspections before finalizing a deal. It also allows for contract cancellation and refunds based on agreed conditions. Here’s why earnest money matters:

• Demonstrate Seriousness: It shows sellers your commitment to purchasing the house, giving you a competitive advantage over other buyers.

• Secure the Property: Once accepted, your offer with earnest money takes the property off the market, providing peace of mind during the purchasing process.

• Strengthen Negotiation: Including earnest money indicates financial readiness and commitment, potentially enhancing negotiation leverage for better terms.

6 Key Contingencies Applied to Earnest Money Deposits

A contingency is a clause outlining a specific requirement for finalizing a sale. Not meeting contingent terms can let either party back out of the deal and keep the earnest money deposit. Standard contingencies include:

1. Mortgage Contingency: Protects buyers if they can’t secure a mortgage, allowing them to walk away with their deposit.
2. Inspection Contingency: Permits cancellation if an inspection reveals significant, costly issues with the property.
3. Appraisal Contingency: This enables buyers to back out if the home appraises lower than the mortgage, preventing financial strain.
4. Title Contingency: Allows cancellation if the seller can’t prove legal ownership, protecting the buyer from future legal issues.
5. Home Sale Contingency: This lets buyers delay closing until their home is sold, preventing dual mortgage payments.

Buyers can negotiate additional contingencies. But, it’s crucial to know deadlines for actions like inspections. Missing them may negate the contract.

Earnest Money vs. Down Payment

Aspect	Earnest Money	Down Payment
Purpose	Demonstrates buyer’s intent	Part of the purchase price
Timing	Paid with offer	Paid at closing
Amount	1-2% of purchase price	5-20% of purchase price
Refundable	Yes, under certain conditions	No, part of the purchase price
Held in Escrow	Yes	No
Risk of Loss	Buyer	Buyer

What Happens to Earnest Money at Closing?

Once the funds are with escrow, they stay secure until closing. If the sale succeeds, 75% of the deposit goes toward the buyer’s down payment. The rest covers closing costs, typically 2-5% of the purchase price, contingent on location and lender fees.

For instance, a $7,500 earnest deposit on a $250,000 home can significantly reduce your upfront costs. However, the deal can fail due to contract-specified issues like inspections or loan denial, refunds are typically outlined in the agreement.

Generally, 60% of earnest money deposits are refunded if deals fall through. The exact amount varies based on the negotiation clauses in your agreement. So, it is crucial to review the contract and understand the refund policy before signing.

Tips to Protect Your Earnest Deposit

To protect your earnest money deposit, you can:

1. Include Contingencies for Defects, Finance, and Inspections: These contingencies protect your deposit in case you discover a major issue or structural flaw in the house. It also helps if you can’t secure the finances as planned.

2. Adhere to Contract Terms: Pay close attention to specified deadlines in your contract. Unable to meet these deadlines could lead to losing your earnest fee.

3. Work With Reputable Professionals: Work with reputable brokers, title companies, escrow companies, and legal firms. Trusted professional guidance ensures the secure handling of your deposit in compliance with the contract terms.

Bottom Line

Earnest money, typically 1-2% of the home’s purchase price, is a vital commitment in the competitive homebuying process. This deposit, held in escrow until closing, shows your intent to purchase and aids in negotiations.

Approximately 75% is used for the down payment, with the rest covering closing costs. Refundability hinges on contract terms, usually tied to factors like failed inspections or loan denial.

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