You’re likely to stumble on earnest money when you buy a house. Many sellers ask for such a requirement when buyers place their offer, especially in a hot buyer’s market. That is because of some key reasons that favor the sellers when a transaction falls apart.
Now, what are those reasons that compel a seller to ask for the deposit money? How does earnest money work in a transaction, and what should buyers know about it? Most importantly, what exactly is earnest money?
What to Know About Earnest Money when You Buy a House
Earnest money also known as Deposit Money, is the funds that buyers put on escrow when they enter a home buying transaction. Such funds prove their commitment to buying a property and that they won’t walk away at the drop of a hat. That is essential for sellers since it gives them enough peace of mind while entertaining the buying process.
Why is such peace of mind crucial for sellers during the home buying process?
Remember that a seller needs to pull out a property from the market when they accept an offer from a buyer. That’s when they move towards closing a deal through the transaction. The thing is, that means closing the doors for other potential buyers to make an offer too.
Sellers fear that a buyer would suddenly walk away while the transaction is going on. That’s possible when a buyer finds another house to purchase or when their mortgage approval fails. When such a situation happens, a seller has no other choice but to put the home back on the market and wait for another buyer to buy a house.
That’s why most sellers ask for deposit money from buyers. When a seller of a home that you want asks for such funds, understand that it gives them peace of mind. If ever you’d walk away because of invalid reasons, they’d keep the deposit money from the escrow.
How does Earnest Money Deposit Works
To further understand earnest money, here are some points that tell you how it works:
Sellers Put Deposit Money Clause in Purchase Agreement
First, sellers include specific clauses in purchase agreements that refer to the earnest money. Such clauses tell about how much a buyer should put in escrow as their earnest money deposit. Moreover, the clauses include conditions that a buyer must follow to keep their cash intact.
What’s with the Purchase Agreement?
It is crucial to note that signing the purchase agreement doesn’t mean you’re 100% sure of buying the property. It only means you have a high interest in closing the deal. Signing the dotted lines means you agree to follow the conditions of the buying process. If you violate any condition, then the seller can keep your earnest money deposit.
What’s about the conditions in the Agreement?
When talking about earnest money deposits, those conditions refer to the valid reasons when you can walk away with your cash. Often, such conditions include nasty problems that home inspection spots in the property. Another usual condition is when the property appraisal shows a higher value than your approved mortgage. Both are likely situations when you buy a house.
On the other side of the coin, the seller would keep your earnest money deposit when you walk away for invalid reasons. For example, you can’t put the transaction to a hault only because you want to go for another house. Doing so means the seller would keep your cash deposit.
Although, things aren’t that simple, especially when putting buyer contingencies on the way.
Buyer Contingencies when Talking about Earnest Money
Think of buyer’s contingencies as your checklist to complete through the buying process. That includes home inspection, home appraisal, and mortgage approval, among other requirements.
Clearing all the buyer’s contingencies means you won’t get your earnest money deposit back for good. Instead, it would go to your home down payment upon closing.
Now, what if you only clear one or a few of those contingencies? You can only get a part of your earnest money deposit while the seller gets the rest. The purchase agreement can tell you about the exact amount you can get back, depending on the contingencies you have cleared.
How Much to Prepare for Earnest Money Deposit?
In many areas, earnest money deposit costs around 1 to 5% of a home purchase price. However, it can go up to 10% in vibrant real estate markets as well.
The thing is, other factors can affect earnest money value when you buy a house.
One good factor is to make your offer look stronger. If you’d offer a higher earnest money deposit, the seller would see you as a serious buyer. That can help you win in a bidding war too.
Where Would the Earnest Money Sit through the Transaction?
The earnest money would sit in an escrow account throughout The buying process. Usually, the listing agent or a real estate lawyer would handle such an account.
What you should be vigilant about is the possible fees for an escrow account. Some escrow accounts impose interest rates while others don’t.
Be Careful of Handing Earnest Money to New Home Builders
There are some crucial points about why you should be careful of handing deposit money to builders for a new home.
First, most builders charge high prices for earnest money deposits. It is even usual for them to impose 10% of the home price. Next, most builders don’t put the cash in an escrow account. Instead, they use the funds for the house-building project.
That’s why you should not miss talking with a real estate lawyer before dealing with home builders.
Essential Tips when Using Earnest Money Deposit
After understanding how this deposit works, you should now learn how to use it properly in a transaction.
1. Read the Purchase Agreement with Your Real Estate Agent
First, remember that you should thoroughly understand the purchase agreement when you buy a house. Of course, that includes understanding the terms and conditions of earnest money deposits as well. You do not want to miss any condition and find yourself in a disadvantage, after all.
That’s why you should read the agreement with your real estate agent.
The best Realtor would help you go through each term in the contract. They can explain everything from a professional perspective, which is vital before you sign the dotted lines.
2. Place the Highest Possible Amount of Earnest Money
Placing an earnest money deposit adds weight to your offer. After all, it suggests to the seller that you’re serious about buying their property.
That’s why it is best to put the highest possible amount you can. Giving such an amount for earnest money deposit also helps you gain an edge in a bidding war.
On a side note, it is a mistake when you don’t put earnest money deposit because you have a mortgage with no down payment. The seller would think twice about accepting your offer.
3. Weigh Earnest Money Deposit with Other Factors in an Offer
The earnest money deposit can make an offer stronger. However, you should weigh it carefully with other factors to avoid horrible regrets later on.
For example, some waive the home inspection while offering high deposit money. You can do the same if you’re ready. However, remember that waiving the home inspection can lead you to a property with nasty problems.
If you’re not sure about waiving contingencies, it is best to avoid doing so when you buy a house. Talking with your agent is also a wise idea.
4. Pay Attention with the Schedules
As discussed, buyer’s contingencies are essential factors when talking about such money deposits. You’d lose your hard-earned money if you miss clearing those contingencies.
That is why you should pay attention to all schedules in the buying process. Then complete all contingencies on time to avoid any drawback.
5. Be Weary about Earnest Deposit Disputes
Avoid these disputes at all costs! Yes, such disputes are common in the industry. However, they take a tedious process to complete, and only the court can decide who to give the cash to. The escrow agent can’t even release the funds even if they know who deserves it.
On a side note, always keep the purchase agreement conditions in mind when deciding about the deposit money. For example, the closing day is near, and you want to walk away from the transaction. Then leave the funds to the seller. Do not make an unwinnable dispute.
Keep these Earnest Money Notes in Mind when You Buy a House today!
Earnest money is a complex term in the real estate industry. Of course, you don’t want to end up in a pitfall only because you fail to understand such a deposit. That is why you should remember these notes about these deposits when you want to buy a home.
Moreover, do not miss talking with your Realtor regarding such points. You can connect with a real estate lawyer for further help as well. Such simple yet wise steps help you buy a house without any problem and avoid disputes.