Earnest money shows the seller that you are in an agreement to buy their house. Find out all about earnest money and how to ensure you don't lose it.
You may be familiar with the old-fashioned word “earnest,” whose synonyms include serious, determined, steady, dedicated. This idea gives rise to the term “earnest money” or the “earnest money deposit” (EMD). Find out what earnest money is, how it works, and how it contributes to your real estate transaction.
When you enter into an agreement to purchase a home, you want to show the seller that you are serious and steady -- that they can count on you to carry through with your agreement. That is the purpose of earnest money, a small deposit that you put down along with your initial offer in order to show your good faith and financial solvency.
While you don’t have to put down earnest money, in almost all transactions an earnest money deposit is included. If you are in a competitive market, in fact, you may need to put even more earnest money down in order to show your serious intentions to make a deal.
EMDs can range from 1% to 5% of the purchase price of the home. In particularly competitive markets or multiple offer situations, higher EMDs are common.
You can write a check for earnest money, though in some markets you will be asked to provide a certified check or wire transfer rather than a personal check. While some real estate brokers can facilitate an EMD by credit card, this is usually a bad idea for a couple of reasons:
● It calls into question your ability to afford the home and the closing process.
● It can negatively impact your debt-to-income-ratio and make it harder for you to qualify for a mortgage.
If you use a credit card for your EMD -- for example, in order to garner rewards points -- consider paying it off immediately, before interest is charged. This will minimize the impact on your credit report.
Your earnest money deposit is put into an escrow account. It should never be given directly to the seller or be deposited into a real estate agent’s personal account. The escrow company will then hold the deposit and fold it into the down payment as a credit at closing.
An earnest money refund is dependent upon the reason that the deal falls through -- and which party was responsible. If, for example, the buyer has a home inspection contingency and decides after the inspection to back out of the contract, as long as he or she does so within the timeframe specified by the contract the EMD should be returned.
On the other hand, if the buyer decides that he or she does not want to continue with the transaction, the EMD will not be returned based on this change of heart.
In California, EMDs usually max out at 3% due to statutory restrictions on liquidated damages. In the event that a higher EMD is put into escrow, any amount above 3% will be returned to the buyer in the event of a breach of contract or other dispute that ends the purchase. Failure to perform a required step in the escrow or closing process can result in the forfeit of the earnest money deposit.
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Learn more at our website or continue reading our Step-by-Step Closing Guide.