Earnest Money Explained

Dated: 02/25/2016

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Do you know what earnest money is and how it can affect your home purchase?

When you’ve found that perfect home and are ready to make an offer, there’s a surefire way to let the seller know you mean business — make sure you include an earnest money deposit.

Earnest money is what shows your good-faith intent in a transaction. The seller sees your financial skin in the game upfront.

Both the buyer and the seller want to make sure the deal goes through, and an earnest money deposit helps give the deal solid footing. It’s important to understand what earnest money is and how it can affect your transaction when buying a home.

Is earnest money a legal requirement to buy a home?

No. But money talks — and deposits keep buyers from changing their minds.

A buyer will think twice about [backing out] if they’ve [got] a lot of money tied up in this [deal]. That kind of built-in financial security makes sellers feel more at ease when accepting an offer.

How much money do you need?

Earnest money amounts vary by area and can range from 1% of the home purchase price to 5%, depending on the type of home you’re purchasing.

The bigger the purchase price, the bigger the binder needs to be. If you’re purchasing a $1 million house, you would need to put more — or what the seller asks for.

You don’t need to pay everything at once, though. If your seller wants a $50,000 deposit, you can negotiate to give $25,000 upfront and another $25,000 after successful completion of any due diligence period.

Why are higher deposits required on most new construction?

Earnest money for new construction can be as high as 50% of the purchase price, but there’s a good reason why developers ask for extra cash. They often front construction costs or borrow funds from a bank, which may want proof that units are sold to qualified buyers.

Developers don’t want buyers to walk away either. Homes customized to a particular buyer’s tastes can have higher construction costs and may not be easily remarketed if the buyer changes their mind.

Are deposits ever nonrefundable?

Real estate contracts dictate timelines and responsibilities for both buyers and sellers. Buyers risk losing their deposit when they don’t comply with the contract’s terms, and sellers lose valuable marketing time.

Contracts can fall through for many reasons, such as if a buyer can’t get financing (provided there’s a mortgage contingency), or if a buyer decides not to follow through with the purchase after an unsatisfactory inspection.

In addition, depending on the market, a seller may negotiate that the deposit is nonrefundable after a certain number of days. Agree to this only if you can take the risk, since as a buyer, you could be giving up your money if you decide to walk away from the property.

In some housing markets with multiple offers, you may want to [agree to a nonrefundable deposit] to make your offer more attractive, or the seller may counter with asking for a nonrefundable binder. This is where your agent’s market knowledge will come into play.

How are disputes handled?

If a deal closes within the contract’s timeline and you’re able to provide documentation, you’ll likely get your money back or, depending on the agreement, it will be applied as a credit toward the purchase price of the home.

But every situation is different, and issues can and do arise. As a consumer, you have to ask your agent how [disputes] are handled. It depends on the dispute resolution process.

When a title company or an attorney’s office holds the deposit in escrow, parties often use mediation or go to small claims court to resolve disputes, which can be pricey.

You have to weigh the cost of mediation and settling versus going to court, which can be very expensive.

Who gets to keep the money?

The broker, a real estate attorney, or a title company “holds” your earnest money deposit. But none of those parties get to keep the money.

One of three scenarios will occur: The buyer is refunded the money because of failed contingencies; the deposit is applied to the purchase price or refunded to the buyer when the sale closes; or the seller receives the deposit because the buyer backed out of the deal for reasons not covered in the contract.

Is it ever fair to forfeit a deposit?

If you back out of the agreement for reasons not covered under your contingency agreement, you may not get your deposit back. Be sure you fully understand how failed contingencies affect both you and the seller to avoid confusion and heartbreak later on.

It may seem as if you’re throwing away money if you forfeit your deposit, but there are financial considerations on the seller’s side when you walk away. As soon as the seller accepted your offer, they may have rented or purchased a new home or put furniture in storage — and they’re definitely were not accepting other offers.

There’s a lot of dominoes that have to fall into the right places when you’re purchasing property. If everyone doesn’t follow through with what they’re supposed to do, it creates expenses.


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Tory Sartwelle

Specializing in Houston's Inner Loop areas and nearby Clear Lake, Friendswood, Pearland, Seabrook, Kemah, League City, Santa Fe, Alvin, and surrounding areas. I help people buy, sell and lease the ....

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