Earnest Money: What Is It and How Does It Work?

Apr 29, 2022

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Are you putting in or planning on putting an offer on a home soon. As a buyer, there are several ways to stand out from the competition and show commitment to a particular home. One way to do this is through earnest money. This exchange of money from buyer to seller shows serious intent on the buyer's part.

You may be wondering: “What is earnest money and how does it work?”. In this article, we will go into detail about what earnest money is, why you should pay it, how much you should offer, the earnest money process, how to get refunded, and how to protect your deposit.

What is Earnest Money?

Earnest money is a “good-faith” deposit that buyers often include in their offer before closing on a house. This money offer shows serious interest in the property which is a good indicator to the seller that the deal will go through. While earnest money is not a requirement, it’s often recommended. In competitive markets, it can be considered a necessity.

Earnest money doesn’t just protect the buyer. For the seller, this deposit provides confidence that the buyer will complete the transaction and purchase the home. Earnest money is usually paid for via wire transfer, personal check, or certified check. The money is held in an escrow account until closing day when it is then used towards the buyer’s closing costs and down payment.

How Much Earnest Money Should You Pay?

The amount of earnest money you put down really depends on the real estate market you are buying in. Earnest money can range from 1-10% of the home’s purchase price. The exact amount of earnest money you pay depends on the following factors.

  • Competition- Some markets are more competitive than others and certain homes within a market will attract much more attention from buyers than others. The more competitive the market, the more earnest money you will want to put down.
  • Market Norms- Different markets have different average norms for how much earnest money should be offered, even without market competition involved. In Georgia, one can expect to put down around 2-3%. However, in some  markets like New York earnest money can be upwards of 10%.
  • Type of Home- Earnest money amount varies by the type of home you are looking to buy. New construction homes usually require a higher earnest money deposit than the typical existing home.
  • Financing- If you are paying through a conventional or government-backed loan, the earnest money amounts are governed by local norms or situational factors. If you are paying through a cash-offer or buying the home as is, you may not have to put any earnest money down at all.

As a buyer, the best way to understand how much earnest money you should put down is to work with a knowledgable, local agent that is familiar with the market. They will be able to give you a good idea of local norms and what amount is likely to put you in good standing.

How Earnest Money Works

The amount of earnest money you plan to deposit is determined during the negotiating phase of buying a home. This earnest money amount is included in your offer along with the offer price, closing date, financing details, and any contingencies. From there, the seller can choose to either accept your offer, negotiate terms until an agreement is made, or reject your offer.

If both the buyer and seller come to an agreement, the terms are drafted into a purchase agreement. When the agreement is signed, the earnest money deposit is then placed into an escrow account. This step should be done 1-3 days after the contract is signed. Missing this deadline will void the contract and allow the seller to back out of the deal.

Once the earnest money is deposited into escrow, the contract goes into full effect. After the deal goes through, your earnest money deposit will be taken out of escrow and be applied to your down payment and/or closing costs.

Can Earnest Money Be Refunded?

Yes, earnest money can be refunded back to you. When you make an offer on a home and the seller accepts, there are agreements made that the seller must meet for the sale to be final. These are known as contingencies. Contingencies can be can include those for home inspections, appraisals, titles, the sale of an existing home, or financing.

Depending on the contingencies made, the buyer can back out of the contract and receive their earnest money deposit back in full. For example, if a home inspection contingency is in place and serious issues are found, the buyer can get their deposit back. Similarly, if the seller fails to follow through on any contingencies and therefore breaks the contract, the buyer can also be refunded their deposit.

Protecting Your Earnest Money

It is important to protect your earnest money and ensure you can get your money back if the deal falls through. When writing out your own contingencies, you want to be crystal clear. The more clear your contingencies are, the safer your earnest money is. Familiarize yourself with the contingencies of the seller as well. Meet all of the deadlines and follow through on all terms set by the seller.

Additionally, earnest money deposits should be handled by a reputable brokerage and escrow company. Professional guidance will be your best bet to make sure that your transaction goes smoothly and, if not, you get your deposit back.

Putting an earnest money deposit down on a home is an important step toward ownership. Understanding what it is and how it works are key to avoiding stress and finding home buying success. To increase your confidence in this process even more, consider SimpleShowing. Our team of agents are here to provide you with the guidance and resources you need to close on your new home.

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