Understanding the Earnest Money Deposit

Understanding the Earnest Money Deposit

The earnest money deposit is an important part of the home-buying process. It tells the seller you’re a committed buyer and helps fund your down payment.

What Is Earnest Money?
Earnest money is a deposit on the house you want to buy. It shows sellers that you are earnest about buying their home.

Without earnest money, you could make offers on many homes, essentially taking them off the market until you decided which one you liked best. Sellers rarely accept offers without deposits.

Assuming that all goes well and you buy the house, the earnest money will go toward the down payment and closing costs. In many circumstances, you can get most of your deposit back if you discover something that you don’t like about the home.

How Much Should You Put Down in the Earnest Money Deposit?
The amount of the deposit varies. In a slow real estate market, $500 or $1,000 might be enough. When there is more demand for the house, the seller will require more — usually 1-3 percent of the offer.

In some markets demand is so great that the seller will look for a higher deposit before accepting your offer over someone else’s. You can sometimes win a bid if you give the seller a large deposit. In fact, the seller may be willing to come down in price a little if you make a bigger deposit. If your deposit is extremely large, your mortgage lender may want to verify the source of the funds. As long as you can show you’ve had the money for at least 60 days, it won’t be a problem.

When Do You Pay the Earnest Money, and Who Holds It?
You hand over earnest money after your offer on a home has been accepted and you have signed the purchase agreement. The title company often holds the deposit. In some states, the real estate agent holds the deposit. Always check the credentials of the firm or broker taking the deposit, and verify that the funds will be held in escrow until the purchase goes through.

Never give the earnest money to the seller. It could be impossible to get it back if something goes wrong.

Can You Get Your Earnest Money Back?
If the deal falls through, a small cancellation fee is usually taken out of the deposit, but the remainder remains in escrow. Whoever holds the deposit determines whether you should get the money back under the terms of the purchase agreement.

Make sure that the purchase agreement covers how a refund is handled. Eager buyers sometimes give up their rights. But keep in mind that even if you are pre-approved for a mortgage loan, you can be declined when you apply for one. Standard contracts allow you to recover your earnest money deposit in this case. You can also usually get your money back if you find problems with the property.

Laura Sherman wrote this article.