Many first time homebuyers are surprised when they have to promise to hand over thousands of dollars when making an offer on a house.
Don’t panic. Earnest money is a normal part of the buying process.
This chunk of change is the money that shows you are serious, or “earnest,” about buying the particular home.
Sellers usually require earnest money because, frankly, it’s quite a risk for them to stop accepting other offers on their home. Sellers want to sell the home as soon as possible, and they don’t have time for wishy-washy buyers. Earnest money provides a little security that you will not bail out at the last minute, wasting valuable time and money.
Is Earnest Money Refundable?
Earnest money can be refundable if the buyer backs out, under some conditions. Within the purchase contract, there will probably be some stated “contingencies.” These are stipulations that must be fulfilled for the buyer to proceed.
For instance, a home inspection contingency will state that the buyer can back out of the transaction without penalty if there are irreconcilable issues with the home.
The financing contingency states that the transaction can be cancelled if the borrower finds out his loan can’t be approved because of an unforeseen problem with his loan application.
Other common contingencies are:
- Appraisal contingency. In case the home does not appraise for the selling price
- Existing home sale. Buyers can make an offer contingent on selling their current home.
- Other property issues. A contingency can be made for lead-based paint, asbestos, roof condition, private well, sewer, or other specific property issues the buyer is concerned about.
If the seller agrees to these contingencies, the buyer can back out of the transaction and receive the earnest money back. Contingencies usually have time periods associated with them, for instance 10 or 15 days from the day the seller accepts the offer.
Sorry, there is no “I’m kind of indecisive” contingency.
How Much Earnest Money do I have to Deposit?
Although there’s no hard-and-fast answer to this question, generally a buyer should consider depositing about 1% of the offered price as earnest money. For instance, on a $200,000 home, the buyer would typically deposit $2000.
However, the amount can vary greatly depending on the local housing market. In a strong market, you may consider depositing earnest money of $4,000 or even $5,000. These amounts would show the seller that you are very serious. The seller may even put your offer ahead of another offer because of a bigger deposit.
In a weak market where a seller is happy to have any buyer on the line, earnest money of $500 or even $250 may suffice. A good real estate agent will be able to suggest an optimal amount based on the market and your situation.
Does My Earnest Money get Applied to Loan Costs?
Yes. Any amount you deposit goes toward the closing costs and/or down payment associated with the home purchase.
Where Does Earnest Money Go?
Fortunately, earnest money isn’t deposited with the seller, loan officer, or even the real estate agent in most cases. It’s usually deposited with the escrow company handling the transaction. Usually, your buyer’s agent will hand-deliver your check to the escrow company shortly after your offer is accepted. The escrow company will cash the check and hold the money.
It’s true that the seller often chooses the escrow company when the home is listed. But any licensed escrow company is operating under strict federal and local laws, and buyers can assume their money is safe there.
Is Earnest Money Required even if I Don’t Need a Down Payment?
In most cases, yes. Unless you are buying in a very weak market, the seller will require earnest money even if you qualify for a loan type that requires no down payment, like a VA home loan or USDA loan.
If the seller is paying for all your closing costs, you will receive your earnest money back at closing of the transaction. If the closing costs aren’t completely covered, the earnest money will be used to pay for them.
Can I use a Promissory Note instead of Earnest Money?
Technically, yes, but your offer may be placed at the bottom of the pile of offers. A promissory note is simply not as strong as a check that can be cashed immediately.
In some states, the earnest money is deposited with a real estate brokerage or firm. In this case, a promissory note may be useful in case the brokerage is less than reputable. Or if you have necessary funds, but they are tied up somewhere, you might use a promissory note while stating a specific date the funds will be available. Still, you risk your offer being passed over.
If you have the money, and an escrow company will be holding the earnest money, you might as well make your offer look better by avoiding a promissory note. Keep in mind that you don’t have to hand over the earnest money check until your offer is accepted.
Earnest Money is Nothing to Be Afraid Of
With a good real estate agent on your side, you’ll be able to determine the amount and timing of your earnest money deposit.
One final word of caution, however. Make sure you have enough liquid funds available so you can write a check for the full amount of your proposed earnest money. Nothing says “flakey buyer” more than delayed earnest money – or worse yet, a bounced earnest money check!