When purchasing a home, earnest money is a key factor in determining if you’ll get the home before the deal closes.
Earnest money is different from a down payment and often a lot less. It’s basically a good-faith gesture and says to the seller that you are serious about purchasing the home.
There are a number of factors that go into ensuring your earnest money satisfies the seller and that you get it back if things don’t work out. In this article, you’ll learn what earnest money is, how much you should put up and how to ensure you get it back if the deal doesn’t work out.
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What Is Earnest Money?
Once you and the seller have come to an agreement on a home purchase price, it’s time to start moving forward with financing, signatures, inspection, and all the transactions/processes that go into purchasing a home. One of the first things you’ll need to do is deposit earnest money.
“Earnest money is what shows your good-faith intent in a transaction,” Cara Ameer, broker associate and real estate agent in Ponte Vedra Beach, FL, told Trulia. “The seller sees your financial skin in the game up-front.”
Sellers will normally require earnest money. It’s usually 1% to 5% of the home purchase price. The amount is determined by the seller. Like most things in a home purchase, you can try to negotiate the earnest amount down. If it is a seller’s market, negotiating down will not likely work.
Even if you have to deposit more than 5%, the home isn’t costing you any more. If the deal successfully completes, the earnest money will go toward your down payment.
When you deposit earnest money, it is held in an escrow account with the seller’s broker, title company, or escrow company. The money shouldn’t go straight to the seller so they can deposit it into their bank account. The escrow account holds the money until certain conditions are met. These conditions (also called contingencies) are those negotiated between you and the seller.
How Much Earnest Money Do You Need?
Earnest money can range from 1% to 5%. Although, 1% to 2% is more common. Sometimes it can also be a fixed amount, such as $5,000 or even $100,000. This will all depend on the seller and how hot the market is.
In a hot market, not only is the home price inflated, but so too will be the earnest money requirement. This might create a situation in which you are able to purchase the home but don’t have enough to meet the much higher earnest money requirement at the start of the deal.
For example, in hot real estate markets on the West Coast with average homes selling for $1,000,000 or more, having $100,000 in earnest money isn't unheard of.
If you aren't paying all cash (or a significant amount of cash), a large earnest money deposit can go a long way towards showing the sellers you mean business.
How to Keep Your Earnest Money
There are a number of ways to lose your earnest money, but the key to keeping it is preparation. Preparation means knowing related deadlines and adding contingencies.
Contingencies allow you to build “get-out” clauses into the deal. Many unforeseen events can arise during the closure process. While you might not have any idea what they are, a contingency protects you against them.
Some contingencies include:
- Not able to get financing
- Home fails inspection
- Title search issues
- Unable to appraise home
“Never give up your right to cancel your purchase until you are 100% certain that you're going to be able to close,” Jeremy Colonna of Matchpoint Funding, told realtor.com.
Lack of contingencies can be favorable to the buyer and the seller may even counter your offer to not include them. Before removing any contingencies, discuss it with your real estate agent and maybe even an attorney. The additional consultation cost can be worth it in the long run. Of course, if the seller insists that you remove contingencies, it may be time to walk away, as you could be putting yourself in a financial situation that will have negative, long-term consequences.
It’s also important to know your contract deadlines. Earnest money will usually have a deadline attached to it. It should be enough time for the deal to complete (two to three months).
If for whatever reason, the deal is taking longer to close and you’re coming up on the deadline, negotiate a new earnest money deadline with the buyer. If the buyer insists on keeping the current deadline, you’re taking a gamble. You might go past the deadline and lock-in the earnest money only to have the deadline fall through. Now, not only are you not getting the house you wanted but your earnest money is gone as well.
Earnest Money vs. Due Diligence Money
In some states, you might ALSO have to provide due diligence money in addition to earnest money. For example, North Carolina requires due diligence money. So what's the difference?
Unlike earnest money, due diligence money is non-refundable should the purchase not move forward. Due diligence money is a good faith deposit that goes directly to the seller. The amount is credited towards the sale on close, but should the deal fall apart, the seller keeps the money.
There are no contingencies for due diligence. During the due diligence period, the buyer is able to cancel the contract for any reason, or no reason at all. This is a bit different than earnest money, where you have a period of time to perform, and you can cancel for specific reasons to get your refund (such as financing, appraisal, etc).
Given the fact that due diligence money is non-refundable, the amount given is much lower - usually $500 to $2,000.
Your Real Estate Agent Is There to Help
Navigating the various earnest money caveats isn’t something you have to do alone. Your real estate agent should also help answer any questions and negotiate contingencies that are favorable to you. But doing some research can go a long way to ensuring your earnest money is not lost.
Remember, nobody will care about your money more than you!
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.