What is Earnest Money?
Earnest money is a deposit made by a purchaser of real estate to evidence their good faith and serious intent to buy the property. This deposit can be seen as a proof of the buyer’s commitment and is customarily provided at the time the sales contract is signed.
Example In Practice
Let’s consider an example to deepen our understanding of earnest money. Suppose Joan is interested in buying a house listed for $300,000. To show her serious commitment, she provides an earnest money deposit of $5,000 when signing the sales contract. This amount serves as a gesture of good faith to the seller, indicating that Joan is a serious buyer and intends to follow through with the purchase.
Once the sale proceeds to the closing stage, the earnest money Joal provided will typically be credited towards her down payment. If, for example, Joan had promised a down payment of $30,000, the $5,000 earnest money deposit would form part of this amount, reducing her remaining balance to $25,000.
Managing Earnest Money
Brokers, who are often intermediaries in real estate transactions, must handle earnest money with due care. They are required to deposit the earnest money into a separate account until the transaction reaches closure. This practice ensures the earnest money is safeguarded and not used for personal or unrelated expenses, thus avoiding what is known as “commingling.”
Benefits of Earnest Money
- Shows Seriousness: Earnest money signifies a buyer’s genuine intent to purchase the property to the seller.
- Prevents Gazumping: Sellers are less likely to consider other offers once a significant earnest money deposit is on the table.
- Initial Contribution: It contributes to the down payment and, thus, plays an integral part in the overall financial planning of a buyer.
FAQs About Earnest Money
Q: Is the earnest money deposit refundable?
A: The refund conditions for earnest money depend on the terms of the sales contract. Typically, if the buyer cancels the transaction due to unmet contingencies, they may recover their earnest money. However, if they back out without a valid reason or contract loophole, they risk forfeiting the deposit.
Q: How much should an earnest money deposit be?
A: The amount varies depending on the real estate market, customary practices, and negotiations between buyer and seller. It usually ranges between 1% to 3% of the purchase price.
Q: What happens to the earnest money if the deal falls through?
A: If contingencies in the contract aren’t met — such as the home inspection results or financing issues — the earnest money is generally refunded to the buyer. In contrast, if the contract contingencies are satisfied but the buyer decides not to proceed, the seller often retains the earnest money as compensation.
Important Keywords
- Sales Contract: Legal agreement between buyer and seller detailing the terms of the property sale.
- Down Payment: Initial, upfront portion of the total amount payable for the property.
- Closing: Final phase in the purchase process where ownership of the property transfers from seller to buyer.
- Broker: Authorized professional who facilitates real estate transactions in exchange for a commission.
- Commingle: The inadvisable practice of mixing a client’s earnest money with personal funds.
Related Terms: down payment, closing, broker, sales contract, commingle, initial deposit, escrow account.
