What is Earnest Money?

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(Newswire.net — July 21, 2020) — Earnest money is the amount of cash you deposit to prove your commitment to purchasing a home or house. It is also referred to as a good faith deposit. 

After a buyer and a seller have entered into an agreement, the seller often removes the home from the market listing as they move into other steps of closing the deal. However, if the deal doesn’t sail through, then the buyer will have to relist the home again. This can lead to a big financial loss. 

This is where an earnest money check comes in. It is intended to provide a financial cover for the seller in case the buyer pulls out of the deal. Earnest money is usually 1 – 3% of the selling price and is deposited in an escrow account until the entire process is over.

If everything goes as planned, then the earnest money goes back to the buyer as a down payment or to cater for other costs. 

If the deal falls through because of the mistake of the seller such as failing to meet the terms listed in the contract after a home inspection, the money will be sent back to the buyer.

Another important reason why depositing earnest money is encouraged is to reduce the chances of a buyer placing offers into several homes – only to walk away after the seller has delisted their property from the market. 

Why is it important to pay earnest money?

Earnest money is a requirement for every home buyer. However, it can be very instrumental if you are purchasing a home from a competitive market. 

Most sellers prefer buyers to deposit the earnest money so that they are guaranteed that the deal won’t fall through. In other words, earnest money acts as a form of insurance or cover to both the seller and buyer. 

Besides, earnest money can also lower the price of the property. This is because the money will be included as a down payment in case the deal sails through. It is just like making advance payment for your home.

How much should one pay as earnest money?

The amount of earnest money is usually determined by the specific real estate market you are shopping for the property. A slow real estate market flooded with homes won’t require a lot of earnest money.

Nonetheless, if you are planning to purchase a home in a high-end real estate market where price wars are commonplace, then placing a higher amount of earnest money is recommended. 

In case you are working as a real estate agent, you should inquire as to how much earnest money is needed. If the property you are eying for has several bidders, then depositing a lower amount of earnest money will only disadvantage you.

How to protect your earnest money as a buyer

There are several things potential buyers can do to protect their earnest money. They include the following:

  • Ensure that contingencies for inspection and financing are included in the contract. Lack of such details will lead to forfeiture of the earnest money in case the house fails a home inspection or the buyers fails to get adequate financing.
  • Understand and stick to the terms of the contract. For instance, if the contract stipulates that the home inspection should be conducted within a specific date, then the buyer must ensure that it happens or risk losing the earnest deposit.
  • Ensure the earnest money is handled well. The money should be deposited to an accredited real estate brokerage firm, Title Company, and the law firm or escrow company. You should not be convinced to deposit the money directly to the seller.

In a nutshell, earnest money might appear just like any other payment but is critical when it comes to purchasing a home. It protects both the buyer and the seller – in case anything happens before the deal is closed.