Last Updated on September 13, 2022
The old adage “Rome wasn’t built in a day,” can certainly be applied to buying a house. Before you are handed the keys on closing day, multiple steps need to be taken to ensure your goal of home ownership is accomplished, and it’s important to understand every part of that process.
One of those key steps that new home buyers might not be as familiar with is an earnest money deposit.
What is it?
In the simplest terms, earnest money is a deposit or “the consideration” you make on a house you’re interested in. The reason for the deposit though is to communicate to the seller that you are serious and committed to buying their home.
With the market being as competitive as it is today, buyers are making offers on multiple properties, some of which they might not actually be fully interested in. Earnest money, therefore, serves as a safeguard to the interests of the seller and the buyer.
While earnest money is not a legal requirement, it has become a standard practice in today’s market. It shows the buyer you are interested, and could become an important part of the contract in the event of a breach.
The deposit is typically given once the sales contract or purchase agreement is signed and considered to be ‘fully executed’, . Due to this, it’s important you have available funds to use for earnest money readily accessible before any offers on homes are made. Some states allow for personal checks, certified funds, wire transfers, ACH transfers, etc. Please don’t ever give cash for an earnest money deposit.
How much should the deposit be?
Though most earnest money deposits are 1-2% of the property’s purchase price, there are multiple factors and variables that can determine what that rate is. It’s important to consider what the market is like, what other earnest money deposits in your area are like, as well as what the seller might have in mind for the deposit. In very competitive markets, deposits can go as high as 10%.
Since all of those answers might not be easy to find, it’s good to discuss these factors with your agent to be as prepared as possible!
What happens to the deposit?
Once you’ve determined your method of payment for the earnest money deposit, , it gets deposited into an escrow account. If all goes as planned throughout the transaction, it will be held in that account until closing, at which time the funds will be credited toward your down payment and closing costs.
If something were to come up to disrupt the purchase of the home,causing the buyer to terminate within the parameters of the contract, the buyers would be entitled to receive the earnest money back in full; however, releases would still need to be signed by buyers and sellers in most cases, in order for the money to be returned or released. Much of the wording regarding the disbursement of earnest money deposits resides in the offer paperwork signed initially.’
Sometimes, to make an offer more enticing, a buyer may make the earnest money non-refundable, in which case they would not get it returned to them, despite any termination. Also, if a buyer doesn’t stay within the timelines and responsibilities of the contract and were to walk away outside of the parameters of the contract for no reason, they put the return of their earnest money at risk.
Let’s take a look at a few different examples:
Hannah moves to Charlotte and goes under contract on a $300,000 house with $6,000 Earnest Money. The money is deposited into an escrow account and they get through all the contingencies of the contract and proceed to closing. The $6,000 Earnest Money deposit is credited towards Hannah’s closing expenses and downpayment.
Hannah moves to Charlotte and goes under contract on a $300,000 house with $6,000 Earnest Money. The money is deposited into an escrow account and through Hannah’s due diligence (contingency) portion of the contract, she decides to terminate the contract. Her agent sends a signed termination to the listing agent, the listing agent gets the seller to sign it, and the $6,000 Earnest Money deposit is returned to Hannah.
Hannah moves to Charlotte and goes under contract on a $300,000 house with $6,000 Earnest Money. The money is deposited into an escrow account and they get through all the contingencies of the contract but Hannah decides she wants to terminate.
Her agents sends a signed termination to the listing agent requesting return of her Earnest Money Deposit but the seller refuses to sign it. Now what happens? That is dependent on each individual state, as the EMD is now being disputed; therefore, it should not be disbursed until an agreement of it’s disbursement happens.
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