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Understanding Earnest Money

If you are in the process of buying a home you want to make sure you have a strong understanding of what earnest money is, why it is important and how you can protect your deposit.

Earnest money, or otherwise called a good faith deposit, is money that the buyer provides when submitting an offer to purchase a piece of property that lets the property's seller know that the buyer is serious about their offer. This is the buyer almost literally putting their money where their mouth is.

Once the earnest money is pledged, if the buyer for some reason should not be able to fulfill their end of the contract then the seller can keep the earnest money. It is important to stop here to let this sink in. Yes, you can loose your earnest money. However, there are certain conditions that will allow you to back out of an offer without loosing your earnest money.

To begin though, lets talk about how much the earnest money is. The answer to this is; it depends. The price of the property and who you are buying the property from will greatly impact how much earnest money will be needed to put down. There is no set rule that governs how much earnest money needs to be put down but the general rule of thumb is 1-2% of the purchase price. Since the seller gets to keep the earnest money if the buyer backs of the deal without a legit reason the higher the earnest money deposit is the more likely it is that the offer on the property will be accepted.

Earnest money should not be held by the seller. It should be held by a third party. This is usually the title company or the lawyer who is handling the closing of the property. This ensures that the laws that govern what happens to the earnest money are followed. A real estate agent will let buyers know when and where to take the earnest money check.

There is a largely accepted false belief out there that the earnest money is given at the time the offer is made. However, this is not true for most cases. For the majority of deals being made out there the earnest money is not actually given until AFTER the offer has been accepted. Therefore you could make more than one offer at a time but only have to pay up on your earnest money once your offer or offers are actually accepted.

There are three possible things that can happen to the earnest money on a deal depending on how the deal is done... or not. The first thing that can happen is that the sale on the property goes through and the earnest money becomes part of the total amount of money that the buyer needs to bring to the closing. The second thing that could happen is that the sale of the property does not go through and the buyer does not have a legitimate reason to back out and therefore the seller ends up keeping the money. The third thing that could happen is that the sale of the property does not go through but the buyer does have a legitimate reason to back out and the earnest money is returned to the buyer.

The legitimate reason that a buyer may have to back out is called a contingency. You may want to consider including some contingencies in your offer if they are necessary for you keeping in mind that the more you include the less likely it is that the seller will accept the offer. The two most common contingencies are; the inspection contingency and the financing contingency. The inspection contingency gives you the ability to inspect everything about the property within a certain time frame and back out of you don't like something you see. On residential homes a 10-day inspection contingency is most common. The financing contingency allows the buyer to back out and get their earnest money back if they find out that their financing falls through for any reason. If you are paying in cash of course there is no need for a financing contingency and some buyers choose not to include this contingency in their offer even if they are using a loan to finance their purchase to make their offer stand out and look stronger. Your choice to include contingencies or not and which contingencies to include in your offer are all about how comfortable you are with risk, what your personal situation is like and how you want to play in today's ultra competitive real estate market.

These are the basics of earnest money but there are a lot more nuances and details to learn about. It is worth conducting your own internet search to educate yourself and always feel free to reach out to me. I am here at your service!


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