During a purchase of a home it is important to show the seller that you are serious about purchasing their home. Typically this can be done using a Good Faith Deposit – also known as Earnest Money.
Earnest money can be a formal way of requesting that the seller take their house off the market to give you time to do home inspections, appraisal, financing or time to sell your existing home. This way the seller knows you have skin in the game and backing out in short of a deal breaker will have them compensated for the time their property is off the market.
You may get a refund of your deposit if you cancel during your due diligence period. (Inspections, Appraisal, Financing or Time to sell your existing home. ) However, if you move past those contingencies and you decide to cancel, most often your seller would be entitled to that money.
Here are some points that can help you make your decision:
What is Earnest Money
Buyers use earnest money as a tool during the purchase of a property. Often in the form of deposit money held in escrow. Earnest money is used to assure the seller that you are a highly prospective and sincere buyer, given that certain conditions are met. Here is an article outlining how can you save up for an earnest money deposit.
While the laws don’t require earnest money, sellers may require it. The amount can be negotiated if you don’t have access to a large liquid fund.
How Much Earnest Money Do You Need?
Most often it is 1% of the purchase price of the home. However, this purely depends on the real estate market you plan to purchase in.
The more money you put down the more you look serious to the sellers. When multiple offers are being put down on a property there is a higher chance the seller will go with another buyer if they offered more earnest money.
At the same time, the more money you put down in the deposit, the more money you stand to lose. Especially during a finding of a deal breaker not mentioned on your contingencies.
How to Protect your Earnest Money
Typically, earnest money is held in an escrow account. Once it is deposited into an escrow account both the buyer and seller have a legal right to the money in that account. Under no circumstances should you entrust your earnest money directly to your seller or a real estate brokerage.
Understand the Contract
To protect the buyer and seller, most contracts will have contingencies appended to them. This allows room for both parties to back out depending on the conditions listed. Read through it yourself or have a lawyer take a look to ensure your side of the deal is met.
Some common contingencies include:
- Inspection Failures
- Issues with Title Searches
- Issues with Land Surveyed
- Unable to Secure Financing
- Issues Appraising the Property
- Unable to Sell Existing Home
It is your responsibility to ensure the contract drafted is read thoroughly. Remember! Laws can vary state to state. State agreement purchase contracts may be used however a lot of agents may use their own private purchase agreements.
Breach of contract
Speak to your agent to ensure you are never in a breach of contract. You should be ready to move forward with the purchase, have a go ahead from the lender, and have the property is appraised for the offer price. You may also negotiate a buy price after an appraisal and inspection is complete. However, if you were to back out after all of that, you would lose your earnest money deposit.
Some common ways the seller may keep your money include:
- Issues Posted Past the Due Diligence Period
- If the Buyer Waived the Contingencies
- Enforcing “Time is of the Essence” Clause (TOE)
- Requesting the Escrow to Cash the Check
If your buyer requests to waive the contingencies, this can be favorable to both the buyer and seller. Waiving of contingencies may allow you to get a better deal on the property. However this can be detrimental in the case of a deal breaker. Always speak with your broker before removing any contingencies. If the seller refuses to find a middle ground, it maybe time to look elsewhere.
How to use Earnest Money to your Advantage
Earnest money shows your purchase power. It isn’t unheard of to use a large sum of money if you are ready to purchase in cash to secure the offer. Seller may even choose a lower priced offer from someone who is offering a larger sum in their earnest deposit. The chances that the seller will favor your bid over others is more likely in those situations.
With due diligence and a good real estate agent you can use the deposit to fund the closing costs. If you deposited $3,000 dollars into your earnest deposit and your closing cost is $10,000 dollars. You would only have to pay the remainder $7,000 dollars at closing.
Closing points to protect you:
- Do not remove contingencies, they are there to mainly protect you as the buyer.
- Pay attention to the contract timelines. Sticking to that schedule should be your priority.
- Do not offer on a property with a earnest money deposit unless you are 100% sure you love it.
Once again, earnest money is an amazing way to secure a deal you really want. Only if you know how to use it. Make sure you speak with your real estate agent and perhaps an attorney before signing any documents regarding earnest money.
In a competitive sellers market using earnest money is the one of the ways you can settle the deal to your favor. Make sure you are committed to purchasing that property before making the jump. A lot of times the bidding process can make people commit to a home they are not in love with. There are many ways to sweeten a deal, don’t try everything in the book because that will lose you money in the long run. A good real estate agent will be able to walk you through any questions you may have regarding what strategies to use to win an offer.