What Is Earnest Money?

Posted by Steve Vincent on Mar 10, 2020 11:30:00 AM

In Purchase Agreement Deposit, Buyers, How much deposit, Due Diligence Period, Earnest Money, Sellers

When you make an offer to purchase a home, it is customary to deposit a sum of money to secure the offer.  In essence, you are telling the seller you are serious about buying the home and are willing to risk a deposit to demonstrate your sincerity as you work through the contract-to-closing process.  Typically, this 'Earnest Money' is held by the real estate broker or attorney in a designated Trust Account and is then applied to the buyers' cash needed to close on the day of closing.

The word that worries most home buyers in the above statement is 'risk.'  They want to know under which circumstances they might lose that deposit should the transaction fall through.  We'll talk about that in a moment, but first:  some basics about Earnest Money.

How much?  There is no set amount, and it is true that we have taken Earnest Money deposits of as little as $100;  but think about that for a moment.  Think like a home seller.  Here comes an offer to purchase your home.  It is probably asking for some concessions from you, things like a lower price or paying some closing costs to accommodate the buyer.  But the buyer is only putting up $100 to demonstrate their sincerity.   What would you do?  Most sellers in this situation counter back at full price with no concessions and ask for an increase in Earnest Money.  By insulting the seller, a token deposit can weaken your offer.

We usually recommend that our buyer clients offer a deposit of up to 1% (and in a few cases more) of the sale price, depending on availability of funds, how much the client likes and wants the house and whether other buyers may also be interested.  Consider the very desirable $250,000 home that suddenly has 3 offers for the seller to consider.  The offers are essentially the same except one comes with a $2,000 deposit, another has a $2,500 deposit and the third has $5,000 in Earnest Money.  The seller is likely to take the offer with the larger deposit.  To him, this looks like an offer from a solid buyer who will do what's necessary to close the transaction.  $5,000 is much harder to walk away from than $2.000!

Where is it?  Though Earnest Money can be held in other places when agreed by all parties, it is usually held in the real estate Broker's or closing attorney's Trust Account.  This is a special checking account set up specifically for holding Other People's Money, including Earnest Money.  It is not the Broker's or attorney's operating account and by law the Broker and attorney cannot touch the money in the account except as specified in the purchase agreement or by agreement of all parties to that agreement.  Trust accounts are carefully examined from time to time by the State Real Estate Commission and any irregularities are cause for disciplinary action and even suspension.  It is serious business.

Back to that original question:  Is my Earnest Money deposit at 'risk?'  Well, it depends.  First, your Earnest Money deposit is fully refundable during the Due Diligence Period. It is also refundable under certain loan programs should the home fail to appraise for the purchase price. Also, it can be refundable if the contract includes a Contingent Sales Addendum. In most situations once the Due Diligence Period has expired, your Earnest Money Deposit is no longer refundable and is at risk if you do not follow through with your purchase.

So what happens to Earnest Money when a sale falls through?  Usually it's very clear why the sale fell through and usually that situation is covered in the contract, so the money is paid according to the contract's terms.  However, if there is a dispute about the deposit - say the buyer wants the deposit returned and the seller claims it as damages - they must first come to agreement about that before the Broker or attorney will pay it to anybody.  These disputes are usually settled person-to-person with a little help from the real estate brokers, but sometimes they end up in the courts (Small Claims if the deposit is $5,000 or less).  If buyer and seller can't agree, the real estate broker may give each 90 days notice and then pay the funds to the Clerk of the Court where they will be held until somebody initiates proceedings to obtain them.

Now that you are sufficiently frightened about the legal ramifications of Earnest Money . . . Relax!  The key is to make an offer on a house you really want, and then to know what the contract requires you to do.  We're pretty careful at GreatNest to make sure you do know what the purchase agreement requires and we work with you to make sure the various deadlines specified are met.  With more that fifteen years in the business and thousands of transactions, we've had virtually no disputes about Earnest Money - it's all about professional, experienced guidance, education and planning. So, offer with confidence.  We will help you get the home of your dreams and minimize the risks you may encounter!