What is Earnest Money and How Does it Work?
When you make an offer on a home, you’ll see the term “earnest money deposit” in your contract. It’s a crucial part of the real estate transaction, and understanding how it works can help you navigate the home-buying journey. So, let’s take a look!
Earnest money is essentially a deposit made by a buyer to demonstrate their commitment to purchasing a specific property. It’s a way of showing the seller that you’re serious about moving forward with the deal. Think of it as a down payment on your future home, but one that’s made before the actual closing.
Here are the key points about earnest money:
Good Faith Payment: When you submit earnest money, you’re essentially saying, “I’m genuinely interested in buying this house, and here’s the money to prove it!”
Taken Off the Market: Once the seller accepts your offer and you provide earnest money, they’ll typically take the property off the market so you can begin your due diligence. This means that the property is no longer available to other buyers so the seller requires assurance that you are serious about proceeding.
Third-Party Custodian: To ensure the safekeeping of the deposit, an escrow company holds the earnest money until the purchase agreement is either completed or terminated.
The amount of earnest money varies based on several factors, including local practices and market conditions. Earnest money deposits typically range from 1% to 3% of the home’s purchase price. You can increase earnest money to 3% once you release contingencies if you decide to offer a lower amount but presenting the full 3% at the beginning of escrow will show the seller that you are serious and ready for a commitment. Keep in mind that sellers may counter your original offer if they want you to increase your commitment.
You’ll usually provide earnest money shortly after your offer is accepted. The exact timing will be laid out in your purchase agreement. The default is 3 business days after acceptance (C.A.R. purchase agreement) but you can ask for more or less time.
So, how do you get your money back?
If everything goes smoothly, your earnest money will be applied toward your down payment at closing. It becomes part of the funds you bring to the table. If you are buying a home for $1,000,000 with cash and you put down 3% earnest money ($33,333), you’ll need to bring $966,667 plus closing costs to close the deal. If you are financing the home with 20% down ($200,000), the earnest money will be applied to the down payment (166,667) and the lender will finance the remaining amount.
If you decide to back out due to a legitimate reason covered by a contingency in your sales contract (such as a failed inspection or financing issues), you should get your earnest money back.
If you decide to walk away without a valid reason (outside the contract’s contingencies), the seller may keep your earnest money. After all, they’ve taken the property off the market, and they could have been entertaining other offers during that time.
Your agent will guide you on an appropriate earnest money amount based on local norms and the specific property but it’s your responsibility to understand the terms related to earnest money in your purchase agreement. Contingencies matter! Show your commitment, but also protect yourself by knowing your rights and responsibilities.
There’s a lot to know when buying a home so make sure to hire a Realtor® and speak to your lender before you begin your search! Happy hunting!
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